Back to GetFilings.com
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 for the fiscal year ended December 31, 2001
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the transition period from __________ to __________
Commission File Number 0-30162
---------------------
FRONTLINE CAPITAL GROUP
(exact name of registrant as specified in its charter)
DELAWARE 11-3383642
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
405 LEXINGTON AVENUE
NEW YORK, NY 10174
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (212) 931-8000
---------------------
Securities registered pursuant to Section 12(b) of the Act:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
- ---------------------------- -----------------------------------------
Common Stock, $.01 par value NONE
Securities registered pursuant to Section 12(g) of the Act: None
---------------------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K, or any
amendment to this Form 10-K. [ ]
The aggregate market value of the shares of common stock held by
non-affiliates was approximately $1 million based on the closing price on the
OTC Bulletin Board for such shares on April 12, 2002.
The number of the Registrant's shares of common stock outstanding was
37,344,039 as of April 12, 2002.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for the Annual Shareholder's
Meeting to be held in June 2002 are incorporated by reference into Part III.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
ITEM
NO. PAGE
- ---- ----
PART I
1. Business ................................................................................. I-1
2. Properties ............................................................................... I-8
3. Legal Proceedings ........................................................................ I-9
4. Submission of Matters to a Vote of Security Holders ...................................... I-10
PART II
5. Market for Registrant's Common Equity and Related Stockholder Matters .................... II-1
6. Selected Financial Data .................................................................. II-2
7. Management's Discussion and Analysis of Financial Condition and Results of Operations .... II-3
7a. Quantitative and Qualitative Disclosure about Market Risk ................................ II-15
8. Financial Statements and Supplementary Data .............................................. II-16
9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ..... II-16
PART III
10. Directors and Executive Officers of the Registrant ....................................... III-1
11. Executive Compensation ................................................................... III-1
12. Security Ownership of Certain Beneficial Owners and Management ........................... III-1
13. Certain Relationships and Related Transactions ........................................... III-1
PART IV
14. Financial Statements and Schedules, Exhibits and Reports on Form 8-K ..................... IV-1
PART I
ITEM 1. BUSINESS
THE COMPANY
FrontLine Capital Group ("FrontLine" or the "Company") was formed on July
15, 1997 and was spun off as a separate public company from Reckson Associates
Realty Corp. ("Reckson Associates") in June 1998. FrontLine is a holding company
with two distinct operating segments: one holds FrontLine's interest in HQ
Global Workplaces, Inc., a company in the officing solutions market and its
predecessor companies ("HQ" or the "HQ Global Segment"), and the other consists
of FrontLine (parent company) ("FrontLine Parent") and its interests in a group
of companies (the "Parent and Other Interests Segment") that provide a range of
services.
On March 13, 2002, HQ filed a voluntary petition for relief under Chapter
11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the District of
Delaware. Such filing may result in the substantial dilution or elimination of
the Company's interest in HQ. As further described below, the Company is in
default in its credit facilities and is in arrears in the payments of dividends
on its preferred stock and in default on its obligations with regard to its
redeemable preferred stock. As a result of the foregoing, the Company may be
required to seek protection from its creditors under the federal bankruptcy
laws.
FrontLine is in default of its debt agreement and has insufficient cash
reserves to continue operations for the next twelve months. Although
negotiations are ongoing, it does not appear likely that a satisfactory
restructuring of these obligations will be achieved. Accordingly, the Company is
currently considering its future options, including seeking protection from its
creditors under the federal bankruptcy laws.
The accompanying consolidated financial statements have been prepared on a
going concern basis of accounting and do not reflect any adjustments that might
result should the Company be unable to continue as a going concern. The
Company's inability to repay or refinance its indebtedness when due, and pay
dividends on its redeemable preferred stock, its recent losses from operations
and the related Chapter 11 proceeding of HQ raise concern about its ability to
continue as a going concern. The appropriateness of using the going concern
basis is dependent upon, among other things (i) confirmation of a plan of
reorganization of HQ under the Bankruptcy Code, (ii) the ability to achieve
profitable operations after such confirmation and (iii) the ability to generate
sufficient cash from operations and through asset sales to meet its obligations.
FrontLine was established with the purpose of identifying and acquiring
interests in operating companies that engage in businesses that provide services
to other businesses. The groundwork for this business was established in 1997,
with investments commencing in 1998. The first investments were in executive
office suites (now known as the flexible officing solutions industry) and
telecommunications infrastructure.
During 1999, the Company rapidly expanded its operations and ownership
position within the flexible officing solutions industry by orchestrating the
merger of three companies and acquiring interests in the combined company that
resulted in an 84% ownership position of the combined company, then operating
under the name of VANTAS Incorporated ("VANTAS"). In addition, FrontLine
increased its infrastructure enabling the acquisition of ownership interests in
an additional 10 companies that each had the goal of leveraging the power of the
Internet to deliver services to other businesses. The ability to deliver this
growth was primarily fueled by access to the public capital markets.
The announcement in January 2000 of the merger of VANTAS with HQ moved
FrontLine to the forefront of the flexible officing solutions industry through
the creation of the world leader in this industry. With a majority common stock
ownership position in the merged entity, the promising growth of the Internet
sector and robust capital markets, FrontLine was well-positioned to capitalize
on the potential of the resulting network of the FrontLine-owned enterprises.
I-1
However, the capital markets changed dramatically in mid-2000 and caused a
reassessment of FrontLine's business plan. In October 2000, FrontLine announced
that, as a result of changing market conditions, it was refining its strategic
plan (the "Restructuring") to highlight its holdings in HQ and to maximize the
value of its other holdings. Additionally, in conjunction with the
Restructuring, FrontLine announced that it would focus its resources and capital
on the businesses within its existing portfolio and cease pursuing new
investment activities.
In conjunction with the Restructuring, and in light of market conditions,
FrontLine reevaluated the carrying values of its ownership interests and as a
result of this reevaluation recorded aggregate impairment charges of $57.7
million through December 31, 2001 and $25.7 million in the fourth quarter of the
year ended December 31, 2000 to reduce the carrying values of these investments
to their estimated fair values.
In June 2001, the Company and HQ terminated discussions regarding a
potential merger with a competitor and the associated fees have been expensed.
HQ also recognized restructuring charges in 2001 related to the closure of
non-performing centers and employee severance related to a management
restructuring and headcount reduction.
HQ GLOBAL BANKRUPTCY
As noted above, HQ Global and certain of its affiliates (collectively, the
"Debtors") filed voluntary petitions for relief under Chapter 11 of the United
States Bankruptcy Code in the United States Bankruptcy Court for the District of
Delaware (the "Court"). The Debtors will continue to operate and manage
properties in the ordinary course of business during the Chapter 11 proceeding.
The Debtors have the exclusive right to propose a plan of reorganization during
the 120-day period following March 13, 2002, which period may be extended by the
Court.
The Debtors anticipate proposing a plan of reorganization in accordance
with the federal bankruptcy laws as administered by the Court. Confirmation of a
plan of reorganization could materially change the amounts currently recorded in
the financial statements. The financial statements do not give effect to any
adjustment to the carrying value of assets, or amounts and classifications of
liabilities that might be necessary as a consequence of this matter. HQ's
bankruptcy filing may result in the substantial dilution or elimination of the
Company's interest in HQ.
Through December 31, 2001, HQ has incurred professional fees of
approximately $5.7 million relating to the bankruptcy proceedings, which are
included in restructuring costs in the accompanying statement of operations (see
note 14).
DELISTING BY NASDAQ
In March 2002, the Company's stock was delisted by Nasdaq as a direct
result of the HQ bankruptcy filing. The Company's common stock currently trades
on the OTC Bulletin Board under the symbol FLCGQ.
DISCONTINUED OPERATIONS
In December 2001, HQ Global's Board of Directors approved a plan to dispose
of HQ's business in Europe. The planned disposition of the businesses in Europe
represents the disposal of a business segment under Accounting Principles Board
("APB") Opinion No. 30, Reporting the Results of Operations -- Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions ("APB 30"). As a result of this
transaction, the consolidated balance sheets as of December 31, 2000 and 2001
and the statements of operations and cash flows for the years ended December 31,
I-2
1999, 2000 and 2001 have been reclassified to present the European businesses as
a discontinued operation. Summarized financial information for the discontinued
operations is as follows (in thousands):
YEAR ENDED DECEMBER 31,
-----------------------
2001 2000
---------- --------
Revenues ............................................. $ 42,078 $ 28,471
---------- --------
Income (loss) before provision for income taxes ...... $ (142,780) $ 3,059
(Provision) for income taxes ......................... (1,838) (1,988)
---------- --------
Income (loss) from discontinued operations, net ...... $ (144,618) $ 1,071
========== ========
The loss from discontinued operations for the year ended December 31, 2001
contains an asset impairment charge of $141.2 million.
The major classes of assets and liabilities of the discontinued operations
included in the consolidated balance sheet were as follows (in thousands):
DECEMBER 31,
-------------------------
2001 2000
--------- ---------
Current assets ................................... $ 14,191 $ 16,793
Property and equipment, net ...................... 8,546 19,671
Investments ...................................... 9,387 30,531
Intangibles and other noncurrent assets, net ..... -- 86,198
Liabilities ...................................... (26,624) (12,848)
--------- ---------
Net assets ....................................... $ 5,500 $ 140,345
========= =========
HQ
HQ is a provider of flexible officing solutions. As of December 31, 2001,
HQ owned, operated, or franchised 385 business centers, which are included in
continuing operations and are primarily located in the United States. There were
40 business centers operating at December 31, 2001 that were held for sale and
included in discontinued operations or in the process of being closed. A
wholly-owned subsidiary of HQ is also the franchiser of 51 domestic and 31
international business centers for unrelated franchisees. Excluding franchised
and managed centers, as April 12, 2002, HQ owned and operated 284 business
centers.
HQ provides a complete outsourced office solution through furnished and
equipped individual offices and multi-office suites available on short notice
with flexible contracts. HQ also provides business support and information
services including: telecommunications; broadband Internet access; mail room and
reception services; high speed copying, faxing and printing services;
secretarial, desktop publishing and IT support services and various size
conference facilities, with multi-media presentation and video teleconferencing
capabilities. HQ also provides similar services for those businesses and
individuals that do not require offices on a full-time basis.
On June 1, 2000, VANTAS, a majority-owned subsidiary of the Company, merged
with HQ Global Workplaces, Inc. ("Old HQ"), an affiliate of CarrAmerica Realty
Corporation ("CarrAmerica"), in a two-step merger (the "HQ Merger"). As a result
of the HQ Merger, the combined company became a wholly-owned subsidiary of a
newly-formed parent corporation, HQ Global Holdings Inc. ("HQ Global"), under
the name HQ Global Workplaces, Inc. See Note 3 to the financial statements
included elsewhere in this Form 10-K. For the year ended December 31, 2000, the
results of operations included in the financial statements in this Form 10-K are
comprised of twelve months of VANTAS and the seven months of Old HQ following
the HQ Merger with HQ Global.
I-3
BUSINESS STRATEGY
Workplace Solutions
- -------------------
HQ offers its clients two office solution plans based on their particular
needs and preferences. These two plans are Full Office Program and Business
Access Program. Details of these services are described below:
The Full Office Program
This program provides clients with fully furnished and equipped individual
offices and suites and a full array of business support services without
substantial investment of time and money, enabling companies to allocate
resources more effectively. In addition to a fully furnished office and access
to such business support services, clients receive the following additional
amenities and benefits:
Infrastructure:
o Desirable business addresses in prime locations
o Mail processing, courier, shipping and receiving services
o High quality full service business environments
o 24/7 access
o Client services area with essential office equipment
o Complimentary beverage service including coffee and tea
o Meeting rooms with audio-visual equipment
o Office supplies
o Access to approximately 400 centers worldwide through operated and
franchised locations
People:
o Professional receptionist to greet guests
o Dedicated administrative staff proficient in business software
o Telephone answering and call screening
o Meeting planning and catering
o Responsive on site management and support teams
o IT support teams
Technology:
o High speed Internet connectivity
o E-Mail
o Telecommunications services
o Webhosting
o Video conferencing
o Telephone and web conferencing
o Additional technology includes: technical support, LAN and other
configurations
I-4
The Business Access Program
This program provides value to clients that need a local presence in a
particular market or access to HQ's worldwide network and utilization of the
many services offered by HQ, but do not need a full-time office. As a result, HQ
offers a part-time plan called the Business Access Program. HQ's clients receive
a prestigious address, building directory lobby listing, personalized telephone
answering, message and voice mail services, facsimile capabilities, incoming
mail handling and use of conference rooms and/or offices as needed.
The Business Access Program provides flexibility for HQ's clients. For
example, as a client grows, it can transfer into a Full Office Program.
Similarly, should a Full Office client need to downsize, it can adjust its
overhead and participate as a Business Access client in a seamless manner.
Additional Services
HQ offers a variety of additional services to its clients on an as-needed
basis and charges for these services according to a price schedule. Such
services, which may be a key determinant in a client's decision to choose a
business center, include word processing and secretarial services, desktop
publishing/graphics design, clerical services (i.e., photocopying, filing,
labeling, concierge services), and technical support services
(hardware/software).
Clients
- -------
As of December 31, 2001, HQ had approximately 43,000 clients, including
both Full Office and Business Access clients, utilizing 31,000 workstations.
Approximately 60% of HQ's Full Office clients are large regional or national
companies, often purchasing HQ's services at multiple locations. National and
regional firms generally prefer doing business with a larger, well-established
business center operator, such as HQ, in order to ensure longevity and
consistency of service, as well as the ability to contract for multiple
locations in multiple markets with a single provider. In return, the largest
business center operators typically obtain more favorable lease terms than
single site operators who are unable to provide this level of service. No single
client accounts for more than 1% of HQ's revenues.
Suppliers
- ---------
HQ's primary suppliers are its landlords from whom it leases office space.
These landlords include primarily large real estate companies from which HQ
leases space at multiple locations. HQ's landlords include Boston Properties,
Inc., CarrAmerica, Duke-Weeks Realty Corporation, Equity Office Properties Trust
("EOP"), Reckson Associates and Shorenstein Properties. No single landlord
accounts for more than 9% of the aggregate annual rental payments made by HQ.
The initial terms of the agreements pursuant to which HQ leases office
space from landlords average approximately 10 years and, in most cases, carry
lease renewal options at 95% to 100% of fair market value. In any given year, a
portion of the leases held in HQ's portfolio of leases will be eligible for
renewal. This lease expiration diversity enables HQ to manage lease rates on a
portfolio basis. In the years ending December 31, 2002, 2003 and 2004, 6.6%,
7.8% and 13.5% of the continuing operations leases are scheduled to expire,
respectively.
Office Service Agreements
- -------------------------
HQ provides furnished office space to clients with flexible terms. A number
of a business center's clients terminate their agreements during the course of a
year and, therefore, maintaining high occupancy requires ongoing sales efforts.
One risk HQ faces is the risk of non-renewals resulting in lower occupancy and
reduced service revenues. Despite the short-term nature of the office service
agreements, many clients elect to renew their office service agreements and
remain clients for periods of time averaging approximately four times longer
than the original term of their service agreement. HQ estimates that the
historical average length of stay of its Full Office clients is approximately
two to three years. At December 31, 2001, HQ occupancy as measured by occupied
offices, for continuing operations business centers owned and operated by HQ
I-5
was approximately 69%. Although HQ's occupancy rates vary from one period to
another and are not the only determinant in its ability to generate revenues and
profits, HQ's continued ability to generate business center operating income is
dependent upon sufficiently high occupancy rates.
Franchise Centers
- -----------------
HQ provides its clients with an additional 82 office center locations,
which are operated under franchise agreements by third party owners. These
franchised centers, of which 51 are located in 11 states and 31 are located in
12 international locations, provide HQ's clients with additional solutions to
their global office needs. HQ receives a franchise royalty from these third
party owners for the use of the HQ name, with royalty percentages ranging from
1.0% to 2.5% of the franchise center's gross revenue. Franchise fees aggregated
$1.5 million for the year ended December 31, 2001, and are included in business
services revenues.
Managed and Joint Venture Centers
- ---------------------------------
As of December 31, 2001, HQ managed three centers in the United States.
Subsequently, two of the managed agreements have expired, leaving one managed
center in HQ's portfolio. Additionally, HQ has entered into a joint venture
agreement with EOP and currently manages one center pursuant to this agreement.
Management fees generally include a base fee plus an incentive fee and certain
profit participations.
Marketing Alliance
- ------------------
HQ has a marketing alliance with Servcorp, a business center operator with
centers primarily located in Asia, Australia and New Zealand, whereby HQ
receives and provides client referrals from and to Servcorp.
The Industry
- ------------
During 2001, the U.S. economy experienced a recession, which had a negative
impact on the users of flexible officing solutions, causing a significant
downturn in the industry. The industry is highly fragmented with over 10% of
total business centers owned by the two largest participants, including HQ.
Several trends are driving the acceptance and usage of business centers,
including:
o the widespread use of business center facilities by national and regional
corporations to support mobile employees;
o small businesses nationwide requiring more flexible office space and
related services;
o home-based businesses and free agents utilizing part-time office
facilities for meetings and support services;
o the continuing trend of corporate downsizing which often results in the
need for temporary office space for former employees seeking new jobs
and/or starting new businesses;
o the growing use and acceptance of enhanced telecommunication and computer
technologies which can help businesses create "virtual offices" without
fixed space requirements; and
o the increased awareness by commercial real estate owners that business
centers can provide amenities to existing tenants (such as conference
facilities and offices for visiting executives) and act as an incubator
for future tenants.
Furthermore, the emergence of certain communications technologies has
played an important role in the evolution of the industry. Improved
telecommunication services and Internet applications have become more frequently
utilized and integrated into business center service offerings. As the industry
I-6
continues to evolve, office equipment and communications technology will become
an increasingly competitive factor. Business center operators are likely to face
pressure to invest in technology in order to offer services such as E-mail and
LANs as well as video conferencing.
Competition
- -----------
The industry is highly fragmented with approximately 10% of total business
centers owned by HQ and the two largest participants, including HQ. In many
markets, HQ's largest competitor may be a locally-owned operator with several
centers. HQ's largest global competitor is Regus plc. Regus has a large
international presence and a smaller but expanding presence in the United
States. HQ may compete with these and other entities in both the search for
attractive business center locations and in attracting and retaining clients in
its business centers as well as skilled managers.
Team Members
- ------------
As of December 31, 2001, HQ employed approximately 1,700 team members
(employees) including 225 corporate team members. None of these team members is
covered by a collective bargaining agreement and HQ believes its relationship
with team members is good. HQ is continually implementing and improving its
operating systems, expanding opportunities and providing training programs for
its team members.
Management compensation consists of base salaries and incentive
compensation based upon HQ's performance and individual team member performance.
In addition, certain team members participate in a stock option plan designed to
motivate long-term contribution to HQ's success.
Geographic Information
- ----------------------
Information by geographic area is provided in Item 2, below. As of December
31, 2001, HQ's continuing operations are primarily located in North America,
except for certain franchise centers.
PARENT AND OTHER INTERESTS SEGMENT
The Parent and Other Interests Segment consists of FrontLine and its
interests in a group of companies, which provide a range of services.
As discussed above, in conjunction with the Restructuring and in light of
market conditions experienced beginning in mid-2000, FrontLine reevaluated the
carrying value of its ownership interests and, as a result of this
re-evaluation, recorded aggregate impairment charges of $57.7 million through
the year ended December 31, 2001 and $25.7 million in the fourth quarter of the
year ended December 31, 2000 to reduce the carrying values of these investments
to their estimated fair values.
FrontLine also has an interest in Reckson Strategic Venture Partners, LLC,
which invests in operating companies with experienced management teams in real
estate and real estate related market sectors which are in the early stages of
their growth cycle or offer unique circumstances for attractive investments, as
well as platforms for future growth.
At December 31, 2001, FrontLine had 4 employees.
See Note 4 to the accompanying Consolidated Financial Statements for
financial information and further discussion and financial data related to our
Parent and Other Interests Segment.
I-7
ITEM 2. PROPERTIES
FrontLine's principal office is located at 405 Lexington Avenue, New York,
New York, 10174. Management believes that such space is sufficient to meet
FrontLine's present needs and does not presently anticipate securing additional
space.
HQ Business Centers at December 31, 2001
The following table sets forth the number of HQ business centers and the
related number of workstations that HQ operated as of December 31, 2001. HQ
centers are located in buildings where HQ leases office space from landlords.
See "Suppliers" in Item 1 to this Form 10-K.
LOCATION CENTERS WORKSTATIONS
- -------- ------- ------------
United States:
Alabama ......................... 2 211
Arizona ......................... 7 893
California ...................... 56 7,000
Colorado ........................ 9 1,309
Washington D.C. ................. 26 3,209
Florida ......................... 12 1,252
Georgia ......................... 18 2,024
Illinois ........................ 27 3,115
Indiana ......................... 3 273
Kansas .......................... 2 251
Massachusetts ................... 16 1,698
Michigan ........................ 6 780
Minnesota ....................... 5 604
Missouri ........................ 3 309
Nevada .......................... 4 429
New Jersey ...................... 16 1,330
New York ........................ 33 4,503
North Carolina .................. 4 527
Ohio ............................ 8 823
Oklahoma ........................ 1 103
Oregon .......................... 3 377
Pennsylvania .................... 4 381
Tennessee ....................... 1 103
Texas ........................... 19 2,607
Utah ............................ 1 103
Washington ...................... 9 1,018
Wisconsin ....................... 1 61
-- -----
U.S. -- Operated Centers ......... 296 35,293
International: ...................
Argentina ....................... 1 100
Mexico .......................... 6 341
--- ------
International Centers ............ 7 441
Franchise Centers ................ 82 6,724
--- ------
Total Centers .................... 385 42,458
=== ======
HQ operates 116 of these centers and approximately 15,000 workstations in
the top five markets of New York City, Los Angeles, Chicago, Washington D.C. and
San Francisco. Additionally, HQ has 82 franchised centers of which 51 are
located in 11 states and 31 are located in 12 international locations. HQ also
manages three business centers for other owners. Overall, as of December 31,
2001, HQ provided its clients officing solutions in 385 centers, with 42,458
workstations in 14 countries.
HQ's corporate headquarters is located at 15305 North Dallas Parkway,
Dallas, Texas.
I-8
ITEM 3. LEGAL PROCEEDINGS
On February 4, 1999, a lawsuit captioned OmniOffices, Inc. et al. v. Joseph
Kaidanow, et al., (Civil Action No. 99-0260) was filed in the United States
District Court for the District of Columbia. This litigation (the "D.C.
Action"), is with two stockholders of Old HQ (f/k/a OmniOffices, Inc.) and
involves the conversion of approximately $111 million of debt previously loaned
to Old HQ by CarrAmerica, into HQ's non-voting common stock. CarrAmerica and Old
HQ initiated the action by filing a complaint seeking a declaratory judgment
that the conversion price was fair, following threats by Messrs. Kaidanow and
Arcoro ("Defendants") to challenge the conversion price. Defendants filed
counterclaims against CarrAmerica, Old HQ and the then current directors of Old
HQ, seeking a judgment declaring the conversion void or voidable, or in the
alternative, compensatory and punitive damages. The stockholders' counterclaim
makes no allegations against HQ. By January 2000, discovery was complete, the
case was fully briefed, and the parties were awaiting a court ruling on HQ and
CarrAmerica's ("Plaintiffs") motion for summary judgment and Defendants' motion
to modify the scheduling order and motion to seal. The case was reassigned
twice, and the two motions were then dismissed without prejudice on September
19, 2000 and September 26, 2000. On November 13, 2000, Plaintiffs filed a motion
to reinstate their summary judgment motion. Defendants filed a cross-motion for
leave to file a cross-motion for summary judgment. The Court permitted the
refiling and took the motion and cross-motion for summary judgment under
advisement. On September 12, 2001, without holding oral argument, the Court
denied Plaintiffs' motion for summary judgment, but granted the Defendants'
cross-motion for summary judgment. Plaintiffs and the directors of old HQ filed
a Notice of Appeal in October, 2001. On February 15, 2002, the D.C. Circuit
announced that oral argument was scheduled for January 16, 2003. On March 17,
2002, the D.C. Circuit referred the appeal to its Appellate Mediation Program.
In re HQ Global Workplaces, Inc. Shareholder Litigation, No. 17996-NC. The
original lawsuit (the "Fiduciary Action"), was brought in Delaware State
Chancery Court on April 17, 2000 by Kaidanow and Arcoro ("Plaintiffs") but was
removed to the Federal District Court for the District of Delaware and then
remanded on Plaintiffs' motion back to Delaware Chancery Court. The action
alleges a breach of fiduciary duty by CarrAmerica Realty Corporation and Old
HQ's directors in approving the HQ Merger transaction. The complaint alleges
among other things that allocation of the purchase price between the UK and U.S.
companies failed to meet the standard of entire fairness, and that CarrAmerica
breached its obligations under the Tag-Along Rights Agreement between Plaintiffs
and CarrAmerica. The lawsuit also alleges an aiding and abetting claim against
the Company as well as a tortuous interference claim against HQ and the Company.
The Plaintiffs in the Fiduciary Action have also brought an appraisal action in
the Chancery Court requesting appraisal of 100,000 of their shares sold in the
HQ Merger. Modest discovery has occurred in the Appraisal Action. The Appraisal
Action and the Fiduciary Action have now been consolidated into one action. On
March 8, 2002, Plaintiffs filed a motion for leave to amend their complaint to
add, inter alia, a breach of warrant agreements claim against HQ and other
claims against FrontLine. On March 15, 2002, HQ filed a notice of bankruptcy
stay, stemming from its March 13, 2002 voluntary petition for Chapter 11
bankruptcy protection in the United States Bankruptcy Court for the District of
Delaware. HQ informed the Court that the consolidated action should be stayed as
to HQ pursuant to the automatic stay provisions of the Bankruptcy Code. At a
status conference held on March 25, 2002, the Vice Chancellor ordered the
parties to work out a scheduling order for the briefing of the motion regarding
the stay of the proceedings.
On or about October 3, 2001, Burgess Services, LLC ("Burgess Services"),
Dominion Venture Group, LLC ("Dominion Venture Group") and certain affiliated
parties commenced an action in Oklahoma State Court against Reckson Strategic
Venture Partners, LLC ("RSVP"), Reckson Associates Realty Corp. ("Reckson"), and
RAP-Dominion LLC ("RAP-Dominion"), a joint venture through which RSVP and
Reckson invested in a venture with certain of the plaintiffs. On April 10, 2002,
the litigation was settled without liability on the part of the Company or the
defendant. In connection with the settlement, the joint venture will be
terminated. As a result of this settlement, the Company determined that no
further impairment was necessary on its carrying value in its investment in
Reckson Strategic.
I-9
In April 2000, the Company entered into an office lease which expires in
December 2010. In January 2001, the Company assigned the lease to HQ. The lease
assignment did not relieve the Company of any of its obligations under the terms
of this lease. At December 31, 2001, HQ was past due on $0.3 million of rent and
had a $2.8 million letter of credit outstanding with the landlord for the
office. Of the $57.6 million HQ restructuring charge recorded in 2001, a $4.8
million accrual applicable to this lease was recorded as an estimate for the
cost of terminating this lease. If the ultimate cost of terminating this lease
exceeds the outstanding letter of credit, then additional cash may need to be
paid by either HQ or the Company. Since HQ is currently in bankruptcy, the
landlord is likely to seek to recover any further damages from FrontLine. As of
December 31, 2001, the remaining lease commitment in excess of the existing
letter of credit was $24.2 million.
The Company also has potential liability under its indemnification of
CarrAmerica for liabilities of CarrAmerica under its guarantees relating to five
HQ leases. In conjunction with the HQ Merger pursuant to the terms of a
stockholders agreement, FrontLine agreed to indemnify CarrAmerica for its
guarantees of certain HQ leases. At December 31, 2001, HQ had $1.4 million in
outstanding letters of credit associated with these 5 leases. Of the $57.6
million HQ restructuring charge recorded in 2001, a $2.3 million accrual
applicable to this lease was recorded as an estimate for the cost of terminating
these leases. As of December 31, 2001, the remaining lease commitments in excess
of the existing letter of credit was $25.4 million.
In addition to the cases set forth above, the Company and its investee
entities are party to claims and administrative proceedings arising in the
ordinary course of business or which are otherwise subject to indemnification,
some of which are expected to be covered by liability insurance (subject to
policy deductibles and limitations of liability) and all of which, including the
cases discussed above, collectively are not expected to have a material adverse
effect on the Company's financial position or results of operations.
Management does not anticipate that these legal litigations will negatively
impact future operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of shareholders during the fourth
quarter of the year ended December 31, 2001.
I-10
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock traded over the counter ("OTC") under the symbol
"RSII" through August 1999 when it began trading on the NASDAQ National Market
("NASDAQ"). In April 2000, the Company's symbol was changed to "FLCG." As a
direct result of the HQ bankruptcy filing in March 2002, the symbol was changed
by NASDAQ to FLCGQ. In March 2002, the Company's common stock was delisted by
NASDAQ and currently trades on the OTC Bulletin Board. The following table sets
forth the quarterly high and low closing bid prices per share of the Company's
common stock reported for each respective quarter. These OTC and NASDAQ market
quotations reflect inter-dealer prices, without retail mark-up, mark-down or
commission and may not necessarily represent actual transactions. Since
inception, the Company has not paid any dividends to its shareholders. Under the
terms of the Company's credit facilities, as long as there are outstanding
advances under such facilities, the Company is prohibited from paying dividends
on any share of its common stock. In addition, the payment of dividends on the
Company's common stock is prohibited unless full distributions have been paid on
both of the Company's Series A and Series B Preferred Stock. The Company is in
arrears with regard to the payment of dividends on its Series A and Series B
Preferred Stock.
FLCG STOCK PRICE
2000
----
March 31 ............. $ 61.750 $ 40.875
June 30 .............. $ 44.625 $ 14.063
September 30 ......... $ 24.250 $ 14.563
December 31 .......... $ 15.750 $ 9.594
2001
----
March 31 ............. $ 10.50 $ 10.06
June 30 .............. $ 1.97 $ 1.01
September 30 ......... $ 0.13 $ 0.08
December 31 .......... $ 0.13 $ 0.10
The number of registered shareholders of the Company's common stock as of
April 12, 2002 was 6,805.
UNREGISTERED SALES OF SECURITIES
As distributions on its Series A 8.875% Convertible Cumulative Preferred
Stock (the "Series A Preferred Stock") which were payable in February 2001, May
2001 and August 2001, FrontLine issued 43,227, 63,895 and 484,973 shares of its
common stock, respectively, to the institutional investor that holds the Series
A Preferred Stock in transactions exempt from registration under Section 4(2).
The Company did not declare or pay the quarterly dividend due on these shares on
November 6, 2001 or February 6, 2002.
On December 13, 2000, FrontLine obtained a $25.0 million preferred equity
facility, initially issuing 15,000 shares of Series B Convertible Cumulative
Preferred Stock (the "Series B Preferred Stock") for net proceeds of $13.9
million. On February 1, 2001, FrontLine drew the remaining $10.0 million of the
facility, issuing 10,000 shares of Series B Preferred Stock for net proceeds of
$10.0 million. These transactions were exempt from registration under Section
4(2).
As noted above, the Company is in arrears with regard to the payment of
dividends on its Series A and Series B Preferred Stock. For information
concerning the failure to pay such dividends, please see Item 7 below.
II-1
ITEM 6. SELECTED FINANCIAL DATA
PERIOD FROM
JULY 15, 1997
YEAR ENDED DECEMBER 31, (INCEPTION) TO
--------------------------------------------------------- DECEMBER 31,
2001 2000(2) 1999(3) 1998 1997
---- ------- ------- ----- ---------------
(IN THOUSANDS EXCEPT SHARE AMOUNTS)
OPERATIONS SUMMARY:
HQ operating revenues .................... $ 470,707 $ 455,490 $ 214,445 $ -- $ --
HQ operating income ...................... 24,354 87,847 27,527 -- --
Corporate general and administrative (3,915) (16,478) (9,509) (2,613) (479)
Equity in net loss and impairment of
unconsolidated companies ............... (36,448) (125,928) (10,266) (3,630) 223
Net loss applicable to common
shareholders ........................... $ (630,408) $ (234,897) $ (39,847) $ (8,147) $ (258)
PER SHARE DATA(1):
Basic and diluted net loss ............... $ (17.03) $ (6.73) $ (1.56) $ (0.56) $ --
BALANCE SHEET DATA (PERIOD END):
Cash and cash equivalents ................ $ 18,139 $ 19,665 $ 32,740 $ 2,026 $ 130
Working capital (deficit) ................ (630,151) (36,833) 17,090 132 11
Ownership interests in and advances
to unconsolidated companies(4) ......... 13,396 39,845 97,833 45,838 5,845
Intangible assets ........................ 16,820 581,680 239,412 -- --
Total assets ............................. 280,768 1,119,452 541,983 58,843 7,519
Long-term debt ........................... -- 440,449 274,380 40,981 --
Total shareholders' (deficiency)
equity(5) .............................. $ (504,690) $ 120,843 $ 114,109 $ 15,968 $4,222
- ----------------
(1) Based on 37,009,891, 34,880,709, 25,600,985 and 14,522,513 weighted average
shares of common stock outstanding for the years ended December 31, 2001,
2000, 1999 and 1998, respectively.
(2) Reflects the operating results of HQ Global Workplaces, Inc. ("Old HQ") for
the period subsequent to June 1, 2000, the date of the merger of Old HQ
with VANTAS Incorporated ("VANTAS"). See Note 3 to the accompanying
consolidated financial statements for further discussion.
(3) Reflects the Company's acquisition and consolidation of a majority
ownership interest in VANTAS as of January 1, 1999.
(4) Includes the carrying value of investments in Reckson Strategic Venture
Partners, LLC of $13,396,000, $28,969,000, $36,626,000, $15,561,000 and
$5,520,000 as of December 31, 2001, 2000, 1999, 1998 and 1997 respectively.
(5) No dividends on the common stock were paid in any of the periods presented.
During the year ended December 31, 2001 and December 31, 2000, the Company
recognized $5,582,000 and $2,119,000, respectively of dividends on and
accretion of preferred stock.
NOTE: Certain prior period amounts have been reclassified to conform to the
current year presentation.
II-2
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the
accompanying financial statements of FrontLine Capital Group (the "Company" or
"FrontLine") and related notes thereto.
The Company considers certain statements set forth in this Annual Report
Form 10-K herein to be forward-looking statements within the meaning of Section
27A of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, with respect to the Company's expectations for future
periods. Certain forward-looking statements involve certain risks and
uncertainties. Although the Company believes that the expectations reflected in
such forward-looking statements are based on reasonable assumptions, the actual
results may differ materially from those set forth in the forward-looking
statements and the Company can give no assurance that such expectations will be
achieved. Certain factors that might cause the results of the Company to differ
materially from those indicated by such forward-looking statements include,
among other factors, an inability to extend and/or amend the terms of the
Company's outstanding indebtedness and HQ Global Holdings Inc. ("HQ" or the "HQ
Global Segment") indebtedness on terms that are favorable to the Company and its
common stockholders, results of any recapitalization of HQ and its bankruptcy,
negative changes in the officing solutions industry or the Internet-related
businesses in which the unconsolidated companies in which we invest operate, a
continued downturn in general economic conditions, increases in interest rates,
a lack of capital availability, ability to satisfy financial covenants,
competition, reduced demand or decreases in rental rates for executive office
suites and other real estate-related risks such as the timely completion of
projects under development, our inability to complete future strategic
transactions, costs incurred in connection with strategic transactions and our
dependence upon our key personnel and the key personnel of HQ and other risks
detailed in FrontLine's reports and other filings made with the Securities and
Exchange Commission. Consequently, such forward-looking statements should be
regarded solely as reflections of the Company's current operating and
development plans and estimates. These plans and estimates are subject to
revision from time to time as additional information becomes available, and
actual results may differ from those indicated in the referenced statements.
CRITICAL ACCOUNTING POLICIES
The consolidated financial statements of the Company include accounts of
the Company and its majority-owned subsidiary. The preparation of financial
statements in conformity with accounting principles generally accepted in the
United States requires management to make estimates and assumptions in certain
circumstances that affect amounts reported in the Company's consolidated
financial statements and related notes. In preparing these financial statements,
management has utilized information available including its past history,
industry standards and the current economic environment among other factors in
forming its estimates and judgments of certain amounts included in the
consolidated financial statements, giving due consideration to materiality. It
is possible that the ultimate outcome as anticipated by management in
formulating its estimates inherent in these financial statements may not
materialize. However, application of the critical accounting policies below
involves the exercise of judgment and use of assumptions as to future
uncertainties and, as a result, actual results could differ from these
estimates. In addition, other companies may utilize different estimates, which
may impact comparability of the Company's results of operations to those of
companies in similar businesses.
PROPERTY AND EQUIPMENT
Office equipment, furniture and fixtures are depreciated using the
straight-line method over the estimated useful lives of the assets, which range
from three to seven years. The cost of HQ's enterprise resource system is being
amortized over seven years. Leasehold improvements are amortized over the lesser
of the term of the related lease or the estimated useful lives of the assets.
IMPAIRMENTS OF OWNERSHIP INTERESTS AND ADVANCES TO UNCONSOLIDATED COMPANIES
The Company continually evaluates the carrying value of its ownership
interests in and advances to each of its investments in unconsolidated companies
for possible impairment based on achievement of business plan objectives and
milestones, the value of each ownership interest in the unconsolidated
II-3
company relative to carrying value, the financial condition and prospects of the
company and other relevant factors. The fair value of the Company's ownership
interests in and advances to privately held companies is generally determined
based on the value at which independent third parties have invested or have
committed to invest in the companies.
IMPAIRMENTS OF LONG-LIVED ASSETS
The Company reviews long-lived assets, including intangible assets, for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by a comparison of the carrying amount of an asset
projected future undiscounted cash flows expected to be generated by the asset
or business center. In preparing these projections, HQ must make a number of
assumptions concerning occupancy rates, rates which will be charged to clients
for workstations and services, and rates of growth of rent expense and other
operating expenses. If such assets are considered to be impaired, the impairment
to be recognized is measured by the amount by which the carrying amount of the
assets exceeds the estimated fair value of the assets.
RISK AND UNCERTAINTIES
The future results of operations and financial condition of HQ will be
impacted by the following factors, among others: the competition in the office
solutions business with respect to, among other things, price, service, and
location; dependence on leases and changes in lease costs; the availability of
capital for expansion; the ability to obtain and retain qualified employees; the
level of difficulty experienced in the integration of acquired businesses; the
competition for future acquisitions; and the ability of HQ to secure adequate
capital.
OVERVIEW AND BACKGROUND
FrontLine is a holding company, with two distinct operating segments: one
holds FrontLine's interest in HQ Global Workplaces, Inc., a company in the
officing solutions market, and its predecessor companies ("HQ" or the "HQ Global
Segment"), the other consists of FrontLine (parent company) ("FrontLine Parent")
and its interests in a group of companies (the "Parent and Other Interests
Segment") that provided a range of services.
In October 2000, FrontLine announced that, as a result of changing capital
market conditions, it was refining its strategic plan (the "Restructuring" - see
Note 14 to the accompanying consolidated financial statements for further
discussion) to highlight its holdings in HQ and to maximize the value of its
other holdings. Additionally, in conjunction with the Restructuring, FrontLine
announced that it would focus its resources and capital on the businesses within
its existing portfolio and cease pursuing new investment activities.
In conjunction with the Restructuring, FrontLine re-evaluated the carrying
values of its investments and recorded aggregate impairment charges of $57.7
million through the year ended December 31, 2001 and $25.7 million in the fourth
quarter of the year ended December 31, 2000, in order to reduce the carrying
value of these investments to fair value.
The presentation and content of the Company's financial statements is
largely a function of the presentation and content of the financial statements
of HQ and its predecessor companies and the other investee entities. As a
result, to the extent these entities change the presentation or content of their
financial statements, as may be required by the Securities and Exchange
Commission or changes in accounting literature, the presentation and content of
the Company's financial statements may also change.
EFFECT OF VARIOUS ACCOUNTING METHODS ON RESULTS OF OPERATIONS
The interests that FrontLine owns in its investee entities and Reckson
Strategic Venture Partners, LLC (the "Reckson Strategic") have historically been
accounted for under one of three methods: consolidation, equity method and cost
method. The applicable accounting method is generally determined based on the
Company's voting interest and rights in each investee.
II-4
Consolidation. Where the Company directly or indirectly owns more than 50%
of the outstanding voting securities of an entity or controls the board of
directors, the consolidation method of accounting is applied. Under this method,
an entity's results of operations are reflected within the Company's
Consolidated Statements of Operations. The entities whose results are
consolidated by the Company are comprised of VANTAS Incorporated ("VANTAS") and
effective with the June 1, 2000 merger (the "Merger") of VANTAS with HQ Global
Workplaces, Inc. ("Old HQ"). The entity representative of Old HQ and its
predecessors, such as VANTAS, is referred to herein as HQ. (See Note 3 to the
accompanying consolidated financial statements for further discussion).
Participation of other shareholders in the earnings or losses of the
consolidated entities is reflected in the caption "Minority interest" in the
Consolidated Statements of Operations. Minority interest adjusts the
consolidated net results of operations to reflect only the Company's share of
the earnings or losses of the consolidated entities.
To understand the Company's results of operations and financial position
without the effect of the consolidation of HQ, Note 4 to the accompanying
consolidated financial statements presents the balance sheets, statements of
operations and cash flows of the Company without the consolidation of
FrontLine's ownership interest in HQ.
Equity Method. Investees whose results are not consolidated, but over whom
the Company exercises significant influence, have been accounted for under the
equity method of accounting. Investments which were accounted for under the
equity method of accounting included: EmployeeMatters, Inc. ("EmployeeMatters"
- - sold in December 2000), OnSite Access, Inc., RealtyIQ Corp. ("RealtyIQ" -
sold in April 2001), UpShot.com and Reckson Strategic.
Cost Method. Investees not accounted for under either the consolidation or
the equity method of accounting are accounted for under the cost method of
accounting. Under this method, the Company's share of the earnings or losses of
these companies is not included in the Consolidated Statements of Operations.
Impairment charges recognized on cost method investments are included in "Equity
in net loss and impairment of unconsolidated companies" in the accompanying
Consolidated Statements of Operations.
RESULTS OF OPERATIONS
The reportable segments in FrontLine's financial statements are the HQ
Segment and the Parent and Other Interests Segment. The following discussion
should be read in conjunction with the accompanying consolidated financial
statements and notes thereto.
HQ
OVERVIEW OF 2001 DEVELOPMENTS
For the fiscal year ended December 31, 2001, HQ's business centers incurred
a general decline in business performance, reflective of the challenging
economic environment experienced throughout the year.
In response to reduced demand and downward pricing pressure for HQ's
products and services, HQ initiated a restructuring program in the second
quarter of 2001 including the closure of business centers and reduction in
workforce. Accordingly, HQ recognized a restructuring charge in the second
quarter related to these actions.
In the third quarter of 2001, HQ defaulted on its principle payments due
under the HQ Credit Facility and also defaulted on the third quarter interest
payment due under the HQ Mezzanine Loan. Additionally, the third quarter
included an asset impairment charge in association with the downturn in business
performance.
In the fourth quarter of 2001, HQ expanded its restructuring program to
include the closure of additional business centers and further reductions in
workforce. Accordingly, HQ recognized a restructuring charge related to these
actions. Additionally, the fourth quarter included an asset impairment charge
due to further deterioration in business performance. Also in the fourth quarter
of 2001, HQ decided to dispose of its European operations.
II-5
On March 13, 2002, HQ filed voluntary petitions for relief under Chapter 11
of the United States Bankruptcy Code in the United States Bankruptcy Court for
the District of Delaware (the "Court"). HQ will continue to operate and manage
properties in the ordinary course of business during the Chapter 11 proceeding,
utilizing a new $30 million credit facility for liquidity, as necessary. HQ
anticipates proposing a plan of reorganization in accordance with the federal
bankruptcy laws as administered by the Court.
RESULTS OF CONTINUING OPERATIONS
YEAR ENDED DECEMBER 31, 2001 AND 2000
Revenues. Total business center revenues for the year ended December 31,
2001 were $470.7 million, representing an increase of $15.2 million, or 3.3%,
from the year ended December 31, 2000. The increase is primarily attributable to
the inclusion of a full year of revenue from business centers acquired in the HQ
Merger on June 1, 2000, offset by a general decline in business performance.
Reflective of the challenging macro-economic environment experienced throughout
2001, business centers experienced reduced demand and downward pricing pressure.
Business centers with twelve months of activity for both periods under
comparison ("Same Center") had revenues for the year ended December 31, 2001 and
2000 of $201.0 million and $241.3 million, respectively, representing a decrease
in 2001 of $40.3 million, or 16.7%, compared with 2000.
Business centers that were acquired during the periods under comparison
("Acquired Center") had revenues for the years ended December 31, 2001 and 2000
of $216.3 million and $156.9 million, respectively, representing an increase of
$59.4 million, or 37.9%, compared with 2000. The increase is attributable to the
inclusion of a full year of revenue from business centers acquired in the HQ
Merger on June 1, 2000.
Business centers with less than twelve months of activity during one of the
periods under comparison ("Development Center") had revenues for the years ended
December 31, 2001 and 2000 of $21.2 million and $11.1 million, respectively,
representing an increase of $10.1 million compared with 2000. At December 31,
2001 and 2000, there were 15 and 12 Development Centers, respectively, excluding
acquired centers open for less than 12 months.
Business centers that were closed, or were in the process of closing,
during the period under comparison ("Closing Center") had revenues for the years
ended December 31, 2001 and 2000 of $32.2 million and $46.2 million,
respectively.
Expenses. Total business center expenses for the year ended December 31,
2001 were $385.5 million, representing an increase of $68.3 million, or 21.5%,
from the year ended December 31, 2000. The increase is primarily attributable to
the inclusion of a full year of expenses from business centers acquired in the
HQ Merger on June 1, 2000.
Same Center expenses for the years ended December 31, 2001 and 2000 were
$159.6 million and $167.6 million, respectively, representing a decrease in 2001
of $8.0 million, or 4.8%, compared with 2000. The decrease is attributable to
reduced center general and administrative costs, as well as lower technology and
business service expenses associated with the decline in related revenue, offset
by certain lease increases and higher bad debt expense.
Acquired Center expenses for the years ended December 31, 2001 and 2000
were $169.9 million and $101.4 million, respectively. The increase is primarily
attributable to the inclusion of a full year of expenses for business centers
acquired in the HQ Merger.
Development Center expenses for the years ended December 31, 2001 and 2000
were $18.7 million and $9.9 million, respectively, representing an increase of
$8.8 million, compared with 2000.
Closing Center expenses for the years ended December 31, 2001 and 2000 were
$37.3 million and $38.3 million, respectively.
II-6
Business Center Operating Income ("BCOI"). For the year ended December 31,
2001, BCOI was $85.2 million as compared with $138.3 million for 2000. The BCOI
as a percentage of total revenues ("BCOI Margin") was 18.1% for the year ended
December 31, 2001 as compared to 30.4% for 2000. The decrease in BCOI Margin can
be attributed to a combination of reduced demand and downward pricing pressure,
reflective of the challenging macro-economic environment experienced throughout
2001.
Same Center BCOI was $41.4 million and $73.7 million for the years ended
December 31, 2001 and 2000, respectively, representing a decrease in 2001 of
$32.3 million or 43.8%, from 2000. The BCOI Margin from Same Centers for the
year ended December 31, 2001 was 20.6% as compared with 30.5% in the
corresponding period in 2000.
Acquired Center BCOI was $46.4 million and $55.5 million for the years
ended December 31, 2001 and 2000, respectively, representing a decrease of $9.1
million, or 16.4%, from 2000. The BCOI Margin for Acquired Centers for the year
ended December 31, 2001 was 21.5% as compared with 35.4% in the corresponding
period in 2000.
Development Center BCOI was $2.5 million and $1.2 million for the years
ended December 31, 2001 and 2000, respectively, representing an increase in 2001
of $1.3 million from the corresponding period in 2000. The increase is
attributable to the number and maturity of Development Centers operating in the
year ended December 31, 2001 compared to the year ended December 31, 2000.
Closing Center BCOI was negative $5.1 million and positive $7.9 million for
the years ended December 31, 2001 and 2000, respectively.
Corporate General And Administrative Expenses. For the years ended December
31, 2001 and 2000, corporate general and administrative expenses were $60.8
million and $50.4 million, respectively. In the year ended December 31, 2001,
expenses include $2.8 million of professional expenses associated with an
abandoned merger and $0.5 million associated with amending loan covenants. By
the fourth quarter of 2001, corporate general and administrative expenses had
been decreased to 8.4% of revenue, compared with 12.9% for the full year of 2001
and 11.1% in 2000.
Merger And Integration Charges. For the years ended December 31, 2001 and
2000, merger and integration charges were zero and $24.7 million, respectively.
For fiscal 2000, merger and integration charges related to the HQ Merger
completed June 1, 2000 and consisted of $11.4 million of payments to cancel
options to purchase common stock held by officers and employees, $9.4 million of
charges related to severance, retention incentives and other benefits, and $3.9
million of professional fees and other expenses.
Restructuring Charges. For the years ended December 31, 2001 and 2000,
restructuring charges were $57.6 million and zero, respectively. For fiscal
2001, restructuring charges related to a reduction in the number of business
centers, the reduction in the associated workforce and professional fees
incurred in conjunction with HQ's restructuring efforts. The charges consisted
of $4.9 million of severance payments for terminated employees, $47.0 million in
estimated costs associated with the closing of business centers and $5.7 million
in professional fees.
Asset Impairments. For the years ended December 31, 2001 and 2000,
impairment of intangible assets was $561.2 million and zero, respectively. Based
on the trend of operating losses as well as HQ's inability to remain in
compliance with its debt arrangements, HQ determined that the value of its
intangible assets was impaired.
Depreciation And Amortization. For the years ended December 31, 2001 and
2000, depreciation and amortization expenses were $70.1 million and $51.4
million, respectively. The increase in depreciation and amortization expense
primarily relates to the inclusion of a full year of depreciation and
amortization expense from assets acquired in the HQ Merger.
Interest Expense. For the years ended December 31, 2001 and 2000, net
interest expense was $44.4 million and $32.3 million, respectively. The increase
in expense is attributable to an increase in borrowing as a result of the HQ
Merger.
II-7
Provision For Income Taxes. For the years ended December 31, 2001 and 2000,
the provision for income taxes, which is comprised entirely of certain minimum
state taxes, was $0.8 million and $3.4 million, respectively.
Minority Interest. Minority interest was allocated a loss of $306.0 million
and income of $7.7 million in the years ended December 31, 2001 and 2000,
respectively.
YEARS ENDED DECEMBER 31, 2000 AND 1999
Revenues. Total business center revenues for the year ended December 31,
2000 were $455.5 million, representing an increase of $241.1 million, or 112.5%,
from the year ended December 31, 1999.
Same Centers had revenues for the year ended December 31, 2000 and 1999 of
$206.7 million and $178.3 million, respectively, representing an increase in
2000 of $28.4 million, or 15.9%, compared with 1999. The increase is due to more
favorable office pricing, an increase in occupancy levels, and an increase in
use of support services.
Acquired Centers had revenues for the years ended December 31, 2000 and
1999 of $226.0 million and $28.8 million, respectively, representing an increase
of $197.2 million compared with 1999. The increase is primarily attributable to
the HQ Merger on June 1, 2000.
Development Centers had revenues for the years ended December 31, 2000 and
1999 of $19.2 million and $0.8 million, respectively, representing an increase
of $18.4 million compared with 1999.
Closed centers had revenues for the years ended December 31, 2000 and 1999
of $3.6 million and $6.5 million, respectively.
Expenses. Total business center expenses for the year ended December 31,
2000 were $317.2 million, representing an increase of $148.2 million, or 87.7%,
from the year ended December 31, 1999.
Same Center expenses for the years ended December 31, 2000 and 1999 were
$143.0 million and $137.4 million, respectively, representing an increase in
2000 of $5.6 million, or 4.1%, compared with 1999. The increase in expenses is
attributable to certain lease increases and support service expenses associated
with increased support service revenues, offset by lower center general and
administrative expenses due to synergies realized in the HQ Merger.
Acquired Center expenses for the years ended December 31, 2000 and 1999
were $153.8 million and $22.8 million, respectively. The increase is primarily
attributable to the inclusion of a full year of expenses for business centers
acquired in the HQ Merger.
Development Center expenses for the years ended December 31, 2000 and 1999
were $17.0 million and $3.1 million, respectively, representing an increase of
$13.9 million, compared with 1999.
Closed Center expenses for the years ended December 31, 2000 and 1999 were
$3.4 million and $5.6 million, respectively.
Business Center Operating Income ("BCOI"). For the year ended December 31,
2000, BCOI was $138.3 million as compared with $45.5 million for 1999. The BCOI
as a percentage of total revenues ("BCOI Margin") was 30.4% for the year ended
December 31, 2000 as compared to 21.2% for 1999. The increase in BCOI Margin is
primarily attributable to more favorable office pricing, increased volume of
higher margin business services, and synergies realized from the HQ Merger.
Same Center BCOI was $63.7 million and $40.9 million for the years ended
December 31, 2000 and 1999, respectively, representing an increase in 2000 of
$22.8 million, or 55.7%, from 1999. The BCOI Margin from Same Centers for the
year ended December 31, 2000 was 30.8% as compared with 22.9% in the
corresponding period in 1999.
Acquired Center BCOI was $72.2 million and $6.0 million for the years ended
December 31, 2000 and 1999, respectively, representing an increase of $66.2
million from 1999. The BCOI Margin for Acquired Centers for the year ended
December 31, 2000 was 31.9% as compared with 20.8% in the corresponding period
in 1999.
II-8
Development Center BCOI was $2.2 million and negative $2.3 million for the
years ended December 31, 2000 and 1999, respectively, representing an increase
in 2000 of $4.5 million from the corresponding period in 1999.
Closed Center BCOI was $0.2 million and $0.9 million for the years ended
December 31, 2000 and 1999, respectively.
Corporate General And Administrative Expenses. For the years ended December
31, 2000 and 1999, corporate general and administrative expenses were $50.4
million and $18.0 million, respectively. Stated as a percentage of total
revenue, corporate general and administrative expenses were 11.1% and 8.4%,
respectively.
Merger and Integration Charges. For the years ended December 31, 2000 and
1999, merger and integration charges were $24.7 million and $26.7 million,
respectively. For fiscal 2000, merger and integration charges related to the HQ
Merger completed June 1, 2000 and consisted of $11.4 million of payments to
cancel options to purchase common stock held by officers and employees, $9.4
million of charges related to severance, retention incentives and other
benefits, and $3.9 million of professional fees and other expenses. For fiscal
1999, merger and integration charges related to certain transactions with
FrontLine, HQ's principal shareholder. Such charges related to acquisitions in
1999 and consisted of $23.7 million of compensation expense, and $3.0 million of
professional fees, business process reengineering and other integration costs
related to the acquisitions.
Depreciation And Amortization. For the years ended December 31, 2000 and
1999, depreciation and amortization expenses were $51.4 million and $15.0
million, respectively. The increase in depreciation and amortization expense
relates to goodwill associated with the mergers and acquisitions, fixed assets
acquired, and an increase in capital expenditures associated with technology
infrastructure additions and leasehold improvements for Development Centers and
Same Centers.
Interest Expense. For the years ended December 31, 2000 and 1999, net
interest expense was $32.3 million and $10.2 million, respectively. The increase
in interest expense is related to an increase in borrowing as a result of the HQ
Merger.
Benefit (Provision) For Income Taxes. The provision for income taxes
consisted of $3.4 million in expense and $2.8 million in benefit for the years
ended December 31, 2000 and 1999, respectively. The provision is comprised
entirely of state taxes.
Minority Interest. Minority interest was allocated income of $7.7 million
and loss of $18.8 million in the years ended December 31, 2000 and 1999,
respectively.
DISCONTINUED OPERATIONS
YEARS ENDED DECEMBER 31, 2001 AND 2000
Income (Loss) From Discontinued Operations. For the year ended December 31,
2001, loss from discontinued operations was $144.6 million, as compared to
income for the year ended December 31, 2000 of $1.1 million. The loss from
discontinued operations for the year ended December 31, 2001 contains an asset
impairment charge of $141.2 million, to reduce the carrying vale to its
estimated net realizable value.
YEARS ENDED DECEMBER 31, 2000 AND 1999
Income (Loss) From Discontinued Operations. For the year ended December 31,
2000, income from discontinued operations was $1.1 million. There were no
discontinued operations in fiscal 1999, as they were acquired in the HQ Merger.
PARENTS AND OTHER INTERESTS
YEARS ENDED DECEMBER 31, 2001 AND 2000
As a result of the Restructuring discussed above, FrontLine changed from a
company which invested in early stage companies which leveraged the Internet
into one which focused on maximizing the value of HQ.
II-9
Parent expenses decreased $33.6 million to $40.1 million in the year ended
December 31, 2001 as compared to 2000, principally due to a $12.6 million
decrease in general and administrative expenses, a $12.1 million decrease in the
amortization of stock compensation and related awards, $10.0 million of costs in
2000 attributable to a development stage company, a $3.5 million increase in net
interest expense reflecting higher average borrowings, a $1.3 million decrease
in restructuring costs and $1.1 million of depreciation and amortization
associated with equipment the Company owned in 2000.
The restructuring costs recognized in 2001 consist of (1) $5.3 million of
professional fees and other expenses, (2) $2.8 million of the long term
incentive plan ("LTIP") costs related to three executive officers who were
terminated in 2001, (3) $1.9 million of severance and related payments made to
employees who were terminated in 2001 and (4) $1.5 million of accelerated
amortization of stock compensation and related awards that resulted from the
termination of certain employees in connection with the Restructuring.
FrontLine's general and administrative expenses were $3.9 million in 2001
compared to $16.5 million in 2000, reflecting the planned reduction in workforce
and the resulting lower recurring general and administrative expenses from the
restructured operations.
A significant portion of FrontLine's net loss is derived from companies in
which it held minority ownership interests. The equity in net loss and
impairment of unconsolidated companies decreased $89.5 million to $36.4 million
in 2001 as compared to 2000. The equity in net loss and impairment of
unconsolidated companies in 2001 consisted of $5.1 million of equity in net
losses and $32.9 million of impairment charges reflecting estimated decreases in
the fair value of certain of the Company's investments, partially offset by a
$1.6 million gain on the August 2001 sale of the investment in NeoCarta and the
December 2001 sale of the investment in Intuit. The impairment charges in 2001
were determined in recognition of both the lack of continuing support FrontLine
planned to provide to certain investee entities following the Restructuring and
the difficult market conditions experienced beginning in mid-2000. Of the $32.9
million of impairment charges recorded, $20.0 million relates to Reckson
Strategic. During the three months ended September 30, 2001, the Company
recognized a $20.0 million valuation impairment based on its assessment of
value, recoverability and probability that this investment would not ultimately
be realized at its otherwise carrying value. The loss for the year ended
December 31, 2000 was entirely comprised of equity in the net losses of
unconsolidated companies. Equity losses fluctuate with the number of investee
entities accounted for under the equity method, FrontLine's voting ownership
percentage in these companies, the amortization of goodwill related to newly
acquired equity method entities, and the results of operations of these
companies. In 2001, FrontLine had either sold or written down all of its
interest in its equity method investees. The results of operations of these
entities are not consolidated within the Consolidated Statements of Operations;
however, FrontLine's share of these companies' losses, as well as all estimated
impairment charges, are reflected in the caption "Equity in net loss and
impairment of unconsolidated companies" in the Consolidated Statements of
Operations. (See Note 4 to the accompanying consolidated financial statements).
The extraordinary item of $2.6 million in 2000 resulted from the write-off
of deferred financing costs relating to the early extinguishment of a $60.0
million credit facility in March 2000.
Dividends on, and accretion of, preferred stock of $5.6 million in 2001
represents dividends on FrontLine's 8.875% Series A Convertible Cumulative
Preferred Stock, which was issued in the first quarter of 2000 and accretion of
FrontLine's Series B Convertible Cumulative Preferred Stock which was issued in
the fourth quarter of 2000. At December 31, 2001, $0.7 million represents
dividends on the Series A Preferred Stock. The Company did not declare or pay
the dividend on the Series A Preferred Stock that was payable on November 6,
2001 and February 6, 2002.
YEARS ENDED DECEMBER 31, 2000 AND 1999
As a result of the Restructuring discussed above, FrontLine changed from a
company which invested in early stage companies which leveraged the Internet
into one which focused on maximizing the value of HQ.
II-10
Parent expenses increased $46.8 million to $73.6 million in the year ended
December 31, 2000 as compared to 1999, principally due to $12.8 million of costs
related to the Restructuring in 2000, a $10.7 million increase in net interest
expense reflecting higher average borrowings, $10.0 million of costs
attributable to a development stage company in 2000, a $7.0 million increase in
general and administrative expenses and a $5.9 million increase in the
amortization of stock compensation and related awards.
The restructuring costs recognized in 2000 consist of (1) $4.6 million of
accelerated amortization of stock compensation and related awards that resulted
from the termination of certain employees in connection with the Restructuring,
(2) $3.4 million of severance and related payments made to employees who were
terminated in 2000 in connection with the Restructuring and (3) $4.8 million of
writedowns of assets determined to be impaired as a result of the Restructuring.
FrontLine's general and administrative expenses were $16.5 million in 2000
compared to $9.5 million in 1999, reflecting the growth in FrontLine's
infrastructure during the second half of 1999 and early 2000 to support its
operations. Since the Restructuring, the Company has substantially reduced its
workforce and related recurring general and administrative expenses.
A significant portion of FrontLine's net loss is derived from companies in
which it held minority ownership interests. The equity in net loss and
impairment of unconsolidated companies increased $115.7 million to $125.9
million in 2000 as compared to 1999. The equity in net loss and impairment of
unconsolidated companies in 2000 consisted of $108.5 million of equity in net
losses and $25.7 million of impairment charges reflecting estimated decreases in
the fair value of certain of the Company's investments, partially offset by an
$8.3 million gain on the December 2000 sale of the investment in
EmployeeMatters. The impairment charges in 2000 were determined in recognition
of both the lack of continuing support FrontLine planned to provide to certain
investee entities following the Restructuring and the difficult market
conditions experienced beginning in mid-2000. Such loss for the year ended
December 31, 1999 was entirely comprised of equity in the net losses of
unconsolidated companies. Equity losses fluctuate with the number of investee
entities accounted for under the equity method, FrontLine's voting ownership
percentage in these companies, the amortization of goodwill related to newly
acquired equity method entities, and the results of operations of these
companies. In 2000, FrontLine had interests in 12 equity method investees for
the entire year, as compared to two interests for the entire year of 1999. All
of these companies incurred losses in 2000 and 1999. The results of operations
of these entities are not consolidated within the Consolidated Statements of
Operations; however, FrontLine's share of these companies' losses, as well as
all estimated impairment charges, are reflected in the caption "Equity in net
loss and impairment of unconsolidated companies" in the Consolidated Statements
of Operations. (See Note 4 to the accompanying consolidated financial
statements).
The extraordinary item of $2.6 million in 2000 resulted from the write-off
of deferred financing costs relating to the early extinguishment of a $60.0
million credit facility in March 2000.
Dividends on, and accretion of, preferred stock of $2.1 million in 2000
represents dividends on FrontLine's 8.875% Series A Convertible Cumulative
Preferred Stock, which was issued in the first quarter of 2000 and accretion of
FrontLine's Series B Convertible Cumulative Preferred Stock which was issued in
the fourth quarter of 2000.
LIQUIDITY AND CAPITAL RESOURCES
HQ
On March 13, 2002, HQ filed voluntary petitions for relief under Chapter 11
of the United States Bankruptcy Code in the United States Bankruptcy Court for
the District of Delaware (the "Court"). HQ will continue to operate and manage
properties in the ordinary course of business during the Chapter 11 proceeding.
HQ anticipates proposing a plan of reorganization in accordance with the federal
bankruptcy laws as administered by the Court.
II-11
In connection with HQ's bankruptcy proceeding, HQ received a commitment for
a $30.0 million credit facility ("Debtor-in-Possession Facility"), with
borrowings permitted for up to nine months in accordance with certain operating
and liquidity covenants. Any borrowings, of which there have been none, will
incur interest at Prime plus 3.0%.
There can be no assurance as to HQ's ability to execute its business plan
and meet its obligations with respect to its Debtor-in-Possession Facility. The
availability of additional capital and the ultimate recapitalization of HQ to
permit it to confirm a plan of reorganization and emerge from bankruptcy
protection is subject to numerous factors, including some that are beyond HQ's
control. In the event HQ is unable to access additional capital or secure a
confirmed plan of reorganization, no assurance can be given that HQ will be able
to meet its future cash requirements.
FRONTLINE
Historically, FrontLine has funded operations and investing activities
through a combination of borrowings under various credit facilities, issuances
of the Company's equity securities and sales of assets. Since the Restructuring,
FrontLine's cash requirements have been substantially reduced. As of December
31, 2001, there is no remaining availability under any FrontLine credit
facility.
FrontLine is in default of its debt agreement and has insufficient cash
reserves to continue operations for the next twelve months. Although
negotiations are ongoing, it does not appear likely that a satisfactory
restructuring of these obligations will be achieved. Accordingly, the Company is
currently considering its future options, including seeking protection from its
creditors under the federal bankruptcy laws.
As a result of HQ filing bankruptcy, a substantial dilution or elimination
of the Company's interest in HQ could occur. As further described below, the
Company is in default in its credit facilities and is in arrears in the payments
of dividends on its preferred stock and in default on its obligations with
regard to its redeemable preferred stock. As a result of the foregoing, the
Company may be required to seek protection from its creditors under the federal
bankruptcy laws. Set forth below is a description of the Company's credit
facilities.
The Company has a credit facility with Reckson in the amount of $100
million (the "FrontLine Facility"). Additionally, Reckson Strategic has a $100
million facility (the "Reckson Strategic Facility") with Reckson to fund Reckson
Strategic investments. Note 15 to the consolidated financial statements
summarizes the terms of the FrontLine Facility and Reckson Strategic Facility
(collectively, the "Credit Facilities"). The Company had $93.4 million
outstanding under the FrontLine Facility at December 31, 2001, and due to
outstanding letters of credit and accrued interest, has no remaining
availability. The Company had $49.3 million outstanding under the Reckson
Strategic Facility at December 31, 2001. These borrowings were utilized to fund
Reckson Strategic investments and its general operations. As long as there are
outstanding amounts under the Credit Facilities, the Company is prohibited from
paying dividends on shares of its common stock or, subject to certain
exceptions, incurring additional debt. The Credit Facilities are subject to
certain other covenants and prohibit advances thereunder to the extent the
advances could, in Reckson's determination, endanger the status of Reckson
Associates as a REIT. Under the Credit Facilities, additional indebtedness may
be incurred by the Company's subsidiaries. The Credit Facilities also contain
covenants prohibiting the Company from entering into any merger, consolidation
or similar transaction and from selling all or any substantial part of its
assets, or allowing any subsidiary to do so, unless approved by the lender. The
Credit Facilities also provide for defaults thereunder in the event debt is
accelerated under another of FrontLine's financing agreements. On March 28,
2001, the Company's Board of Directors approved amendments to the Credit
Facilities pursuant to which (i) interest is payable only at maturity and (ii)
Reckson may transfer all or any portion of its rights or obligations under the
Credit Facilities to its affiliates. These changes were requested by Reckson as
a result of changes in REIT tax laws. In addition, the Reckson Strategic
Facility was amended to increase the amount available thereunder to up to $110
million (from $100 million).
On September 11, 2000, FrontLine amended its $25.0 million credit agreement
(the "FrontLine Bank Credit Facility"). Borrowings under the FrontLine Bank
Credit Facility are secured by a 20.51% common ownership interest in HQ and bear
interest at the Prime rate plus 2%. Any outstanding borrowings under the
II-12
FrontLine Bank Credit Facility were due on October 25, 2001, as a result of
various extensions exercised by FrontLine in May 2001. At September 30, 2001,
FrontLine had fully borrowed the FrontLine Bank Credit Facility. The FrontLine
Bank Credit Facility provides for a default thereunder in the event debt is
accelerated under another of FrontLine's financing agreements or if there is a
default under certain HQ financing agreements. The FrontLine Bank Credit
Facility contains, among others, covenants relating to the financial ratios of
HQ and covenants prohibiting the Company from (i) transferring, conveying,
disposing of, pledging or granting a security interest in any of the collateral
previously pledged under the FrontLine Bank Credit Facility, (ii) terminating,
amending or modifying any organizational or other governing documents of the
Company or HQ without first obtaining the lender's prior written consent, (iii)
violating certain specified financial ratios, (iv) exceeding $25,000,000 of new
indebtedness, and (v) declaring or paying cash dividends on any class of the
Company's stock. Subsequent to September 30, 2001, the Company has not repaid
the principal or paid any interest applicable to this period and accordingly is
at the forbearance of the bank. There is no remaining availability under the
Credit Facilities. As a result of the Company's failure to pay the principal and
interest upon maturity on the FrontLine Bank Credit Facility, an event of
default has occurred under the credit facilities with Reckson.
During the three months ended March 31, 2000, the Company completed
preferred stock offerings of 26,000 shares of Series A Preferred Stock at a
price of $1,000 per share with net proceeds of $24.6 million. These shares are
convertible into the Company's common stock at a price of $70.48. The Company
did not declare or pay the quarterly dividend due on these shares on November 6,
2001 and February 6, 2002. Accordingly, future dividends will accrue at a higher
rate of 10.875%. In addition, since dividend distributions are in arrears for
more than two quarterly periods, holders of the Company's preferred stock are
entitled to elect two additional members to the Company's Board of Directors.
While the Company's $25 million of Series B Preferred Stock is outstanding,
the holders have consent rights for certain significant transactions, including
the incurrence of additional debt by the Company or HQ, the issuance of equity
securities senior to, or on a parity with, the Series B Preferred Stock or the
issuance by HQ of preferred stock. These securities also contain certain
covenants relating to HQ. In addition, the securities include a redemption
premium of 27.5%. Since securities were not redeemed prior to December 13, 2001,
the securities (including the amount of the redemption premium) have become
convertible at the holder's option into FrontLine common stock at the initial
rate of $13.3875 per share, the preferred stock has become a voting security on
an "as-converted" basis, and quarterly dividends have become payable from the
date of initial issuance at the annual rate of 9.25%. In addition, since the
Company did not pay the dividend on the Series B Preferred Stock in December
2001, the holders of such stock have the right to vote on an "as converted"
basis on any matters that holders of common stock are permitted to vote upon and
to elect two members to the Company's Board of Directors. Securities have a
mandatory redemption requirement at a 27.5% premium, which has been triggered as
a result of uncured events of default. In addition, the consent of two-thirds of
the holders of the Company's Series A Preferred Stock is necessary in order to
issue any equity securities ranking senior to the Series A Preferred Stock. The
Company is also prohibited from paying dividends on its common stock unless full
distributions have been paid on both the Series A Preferred Stock and Series B
Preferred Stock. The Company is in arrears with regard to the payment of
dividends on its Series A and Series B Preferred Stock.
Currently, the Company has a short-term letter of credit in the amount of
$0.4 million, which is being utilized as a security deposit.
The Company has entered into a stockholders agreement (the "HQ Stockholders
Agreement") with certain of the stockholders of HQ Global which provides them
with rights to put up to approximately 3.1 million shares of HQ Global (the "HQ
Shares") to the Company during the two years subsequent to the HQ Merger if HQ
Global has not completed an initial public offering of its shares. On February
25, 2002, such stockholders irrevocably waived their Put Rights.
FrontLine's operations do not require significant capital expenditures.
There were no significant capital expenditure commitments as of December 31,
2001.
II-13
On October 17, 2000, the Company's Board of Directors announced that it
adopted a Shareholder Rights Plan (the "Rights Plan") designed to protect
shareholders from various abusive takeover tactics, including attempts to
acquire control of the Company at an inadequate price, depriving shareholders of
the full value of their investment. A description of the Rights Plan is included
in Note 11 to the consolidated financial statements included elsewhere in this
Form 10-K.
There can be no assurance as to the Company's ability to execute its
business plan and to meet its obligations with respect to its credit facilities.
If additional funds are raised through the issuance of equity securities,
existing shareholders may experience significant dilution. The availability of
additional capital is subject to numerous factors including some that are beyond
the Company's control. In the event the company is unable to access additional
capital, no assurance can be given that it will be able to meet its future cash
requirements.
The Company has formed a committee of its Board of Directors, comprised
solely of the independent directors of the Board, in order to address conflicts
that may arise in connection with the Company's credit facilities with Reckson
Operating Partnership. The committee has retained legal counsel in connection
with its responsibilities.
In March 2002, the Company's stock was delisted by Nasdaq as a direct
result of the HQ bankruptcy filing. The Company's common stock currently trades
on the OTC Bulletin Board under the symbol FLCGQ.
INFLATION
HQ
Certain of HQ's leases include increases in annual rent based on changes in
the consumer price index or similar inflation indices. HQ's contracts with
clients generally range from six to twelve months in duration. Accordingly, HQ
may have the ability to pass on any inflation related increased costs at the
time of renewal of such contracts.
FRONTLINE
Management believes that inflation did not have a significant effect on its
results of operations during any of the periods presented.
II-14
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
HQ
The primary market risk facing HQ is interest rate risk on the HQ Credit
Facility. HQ mitigates this risk by entering into hedging instruments on a
portion of its outstanding balances. In addition, HQ may elect to enter into
LIBOR contracts on portions of the HQ Credit Facility, which locks in the
interest rate on those portions for 30, 60 or 90-day periods. The HQ Credit
Facility bears interest ranging from either 3.25% to 4.00% over applicable
LIBOR, or alternatively 2.25% to 3.00% over prime, generally at HQ's election.
As of December 31, 2001, HQ had hedged the interest rates on approximately
$103.5 million of the HQ Credit Facility using various instruments with various
expiration dates through September 30, 2002. These instruments lock in the
maximum underlying three-month LIBOR at levels between 7.93% and 9.00%.
An increase in interest rates will have a negative impact on the net income
of HQ due to the variable interest component of the HQ Credit Facility. Based on
current interest rate levels, a 10% increase in underlying interest rates will
have a 6.3% increase in interest expense, ignoring the short-term impact of
remaining terms under current LIBOR hedge contracts.
Following the HQ Merger, HQ is conducting more of its operations in foreign
currencies, primarily the British Pound. Due to the nature of foreign currency
markets, there is potential risk for foreign currency losses as well as gains.
Currently, HQ has not hedged its foreign currency risk.
HQ has not, and does not plan to, enter into any derivative financial
instruments for trading or speculative purposes. As of December 31, 2001, HQ had
no other material exposure to market risk.
FRONTLINE
Interest Rate Risk
FrontLine faces interest rate risk on its Credit Facilities and the
FrontLine Bank Credit Facility. The Company has not hedged interest rate risk
using financial instruments. The Credit Facilities bear interest at the greater
of the prime rate plus 2% or 12% (with interest on balances outstanding more
than one year increasing by 4% of the previous year's rate). The FrontLine Bank
Credit Facility bears interest at LIBOR plus 5% for one, two, three or six-month
interest periods, as elected by FrontLine. The rates of interest on the Credit
Facilities and the FrontLine Bank Credit Facility will be influenced by changes
in the prime rate and LIBOR. A significant increase in interest rates may have a
negative impact on the financial results of the Company due to the variable
interest rate (in excess of 12%) under the Credit Facilities.
The following table sets forth FrontLine's obligations with respect to the
Credit Facilities and the FrontLine Bank Credit Facility, principal cash flows
by scheduled maturity, weighted average interest rates and estimated fair market
value at December 31, 2001 (in thousands, except rates).
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------
2002 2003 2004 2005 2006 THEREAFTER TOTAL FAIR VALUE
---- ---- ---- ---- ---- ---------- ----- ----------
Variable rate ................. $ 25,000 $ 142,061 -- -- -- -- $ 167,061 $181,963
Average interest rate ......... 8.75% 12.51% -- -- -- -- 11.95% --
Equity Market Risk
FrontLine faces equity market risk in its ownership interests in its
unconsolidated companies. During the year ended December 31, 2001, FrontLine
recognized impairment charges to reflect decreased valuations for certain of its
investments as a result of unfavorable market conditions and other factors (see
Note 4 to the accompanying consolidated financial statements for further
discussion). As a result of such impairment charges, along with the recognition
of FrontLine's equity in the net losses of certain ownership interests, the
II-15
carrying value of FrontLine's ownership interests in and advances to
unconsolidated companies, at December 31, 2001 was $13.4 million, approximately
4.8% of total assets, thereby mitigating FrontLine's future equity market risk
related to these interests.
FrontLine also held marketable equity securities with a carrying value of
$21.9 million as of December 31, 2000. In the first quarter of 2001, FrontLine
sold substantially all of these securities at an average price similar to the
per share carrying value at December 31, 2000, thereby mitigating the equity
market risk related to these securities.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this item is included in Item 14 of this Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
II-16
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information contained in the section captioned "Proposal I: Election of
Directors" of the Company's definitive proxy statement for the 2001 annual
meeting of shareholders is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information contained in the section captioned "Executive Compensation"
of the Company's definitive proxy statement for the 2001 annual meeting of
shareholders is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information contained in the section captioned "Principal and
Management Stockholders" of the Company's definitive proxy statement for the
2001 annual meeting of shareholders is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information contained in the section captioned "Certain Relationships
and Related Transactions" of the Company's definitive proxy statement for the
2001 annual meeting of the shareholders is incorporated herein by reference.
III-1
PART IV
ITEM 14. FINANCIAL STATEMENTS AND SCHEDULES, EXHIBITS AND REPORTS ON FORM 8-K
(a) (1 and 2) Financial Statements and Schedules
The following consolidated financial information is included as a separate
section of this annual report on Form 10-K:
PAGE
----
Report of Independent Auditors ..................................... IV-8
Consolidated Balance Sheets as of December 31, 2001 and 2000 ....... IV-9
Consolidated Statements of Operations for the years ended
December 31, 2001, 2000 and 1999 ................................. IV-10
Consolidated Statements of Shareholders' (Deficiency) Equity for
the years ended December 31, 2001, 2000 and 1999 ................. IV-11
Consolidated Statements of Cash Flows for the years ended
December 31, 2001, 2000 and 1999 ................................. IV-12
Notes to Consolidated Financial Statements ......................... IV-13
All schedules are omitted since the required information is not present in
amounts sufficient to require submission of the schedule or because the
information required is included in the financial statements and notes thereto.
IV-1
(a)(3) EXHIBITS
EXHIBIT FILING
NUMBER REFERENCE DESCRIPTION
- ------- --------- ------------------------------------------------------------------------------------------
3.1 4 First Amended and Restated Certificate of Incorporation
3.2 8 Amended and Restated By-Laws of Registrant
4.1 9 Specimen Common Stock Share Certificate
4.2 17 Form of Series A Preferred Stock Certificate
4.3 13 Form of Series B Preferred Stock Certificate (included in Exhibit 4.5)
4.4 17 Certificate of Designations establishing the Company's Series A Convertible Cumulative
Preferred Stock
4.5 13 Certificate of Designations establishing the Company's Series B Convertible Cumulative
Preferred Stock
4.6 12 Rights Agreement, dated as of October 19, 2000, between the Company and American Stock
Transfer & Trust Company, which includes as Exhibit B thereto, the Form of Rights
Certificates
4.7 8 Warrant, dated December 7, 1999, to purchase 100,000 shares of common stock
4.8 8 Warrant, dated December 7, 1999, to purchase 100,000 shares of common stock
4.9 17 Warrant, dated June 29, 2000, to purchase 1,000,000 shares of common stock
4.10 17 Warrant, dated June 29, 2000, to purchase 450,000 shares of common stock
4.11 17 Warrant, dated June 29, 2000, to purchase 50,000 shares of common stock
4.12 17 Form of Warrant for the Company's outstanding public warrants
10.1 8 Amended and Restated Credit Agreement between Reckson Operating Partnership, L.P.
("ROP") and the Company relating to the operations of Reckson Strategic Venture Partners,
LLC, dated August 4, 1999
10.2 8 Amended and Restated Credit Agreement between ROP and the Company relating to the
operations of the Company, dated August 4, 1999
10.3 10 Amendment to the Amended and Restated Credit Agreements between ROP and the
Company, dated November 30, 1999
10.4 17 Second Amendment to the Amended and Restated Credit Agreements between ROP and the
Company
10.5 12 Amended and Restated Revolving Line of Credit Agreement together with the Amended and
Restated Revolving Promissory Note, each dated September 11, 2000, among the Company
and Bankers Trust Company
10.6 18 Letter Amendment, dated as of June 30, 2001, to the Amended and Restated Revolving Line
of Credit Agreement, dated September 11, 2000, between the Company and Bankers Trust
Company.
10.7 12 Equity Interest Pledge and Security Agreement, dated as of May 31, 2000, between the
Company and Bankers Trust Company
10.8 12 Confirmation and Amendment of Equity Interest Pledge and Security Agreement, dated as of
September 11, 2000
10.9 13 Securities Purchase Agreement, dated as of December 13, 2000, by and between the
Company and Deutsche Bank Sharps Pixley Inc.
10.10 13 Registration Rights Agreement, dated as of December 13, 2000, by and between the
Company and Deutsche Bank Sharps Pixley Inc.
10.11 4 Intercompany Agreement, between the Company and ROP, dated May 13, 1998
10.12 1 1998 Stock Option Plan
10.13 4 1998 Employee Stock Option Plan
10.14 6 1999 Stock Option Plan
10.15 8 2000 Employee Stock Option Plan
10.16 17 Long-Term Incentive Plan
10.17 1 Employment Agreement of Steven H. Shepsman
10.18 1 Employment Agreement of Seth B. Lipsay
10.19 4 Limited Liability Company Agreement of Interoffice Superholdings, LLC
IV-2
EXHIBIT FILING
NUMBER REFERENCE DESCRIPTION
- ------- --------- -------------------------------------------------------------------------------------------
10.20 1 Limited Liability Company Agreement of OnSite Ventures, LLC
10.21 1 Limited Liability Company Agreement of RSVP Holdings, LLC
10.22 1 Operating Agreement of Reckson Strategic Venture Partners, LLC ("RSVP")
10.23 1 Supplemental Agreement to Operating Agreement of RSVP
10.24 2 Operating Agreement of Dominion Venture Group LLC
10.25 5 Investor Rights Agreement, by and among OnSite Access, Inc. and certain investors and
individuals within management
10.26 5 Voting Agreement, by and among OnSite Access, Inc. and certain investors
10.27 5 Purchase Agreement regarding Series B, Series C and Series D Preferred Stock of OnSite
Access, Inc.
10.28 5 Certificate of Designation of Series A, Series B, Series C and Series D Preferred Stock of
OnSite Access, Inc.
10.29 14 Letter Agreement, dated as of September 29, 1999, among the Company, RSI I/O Holdings,
Inc., RSI-OnSite Holdings LLC, RSI-OSA Holdings, Inc., JAH Realties, L.P., Veritech
Ventures LLC and JAH I/O LLC
10.30 14 Letter of Amendment to Letter Agreement, dated as of September 23, 1999, among the
Company, RSI I/O Holdings, Inc., RSI-OnSite Holdings LLC, RSI-OSA Holdings, Inc., JAH
Realties, L.P., Veritech Ventures LLC and JAH I/O LLC
10.31 15 Agreement and Plan of Merger by and among HQ Global Workplaces, Inc. and CarrAmerica
Realty Corporation and VANTAS Incorporated and the Company, dated as of January 20,
2000
10.32 15 Stock Purchase Agreement between CarrAmerica Realty Corporation and the Company,
dated as of January 20, 2000
10.33 15 Stock Purchase Agreement among CarrAmerica Realty Corporation, OmniOffices (UK)
Limited and OmniOffices (Lux) 1929 Holding Company S.A. and VANTAS Incorporated
and the Company, dated as of January 20, 2000
10.34 8 Subscription Agreement, dated as of February 7, 2000 between the Company and VANTAS
Incorporated
10.35 16 First Amendment to Agreement and Plan of Merger by and among VANTAS Incorporated
and the Company, on the one hand, and HQ Global Workplaces, Inc. and CarrAmerica
Realty Corporation, on the other hand.
10.36 16 First Amendment to the Stock Purchase Agreement by and between CarrAmerica Realty
Corporation and the Company
10.37 16 First Amendment to the Stock Purchase Agreement by and between CarrAmerica Realty
Corporation, OmniOffices (UK) Limited, OmniOffices (Lux) 1929 Holding Company S.A.,
VANTAS Incorporated and the Company
10.38 11 Second Amendment to the Agreement and Plan of Merger by and among VANTAS
Incorporated and the Company, on the one hand, and HQ Global Workplaces, Inc. and
CarrAmerica Realty Corporation, on the other hand, dated as of May 31, 2000
10.39 11 Stockholders Agreement by and among the Company, HQ Global Workplaces, Inc.,
CarrAmerica Realty Corporation and the other parties named therein, dated as of June 1,
2000
10.40 11 Registration Rights Agreement by and among the Company and CarrAmerica Realty
Corporation, dated as of June 1, 2000
10.41 11 Agreement and Plan of Merger by and among HQ Global Workplaces, Inc., HQ Global
Holdings, Inc. and HQ Merger Subsidiary, Inc., dated as of June 1, 2000
10.42 11 Exchange Agreement by and between the Company and HQ Global Holdings, Inc., dated as of
May 31, 2000
10.43 11 Indemnification and Escrow Agreement by and among the Company, CarrAmerica Realty
Corporation and the other parties named therein, dated as of June 1, 2000
10.44 11 Purchase Agreement by and among the Company, HQ Global Holdings, Inc. and EOP
Operating Limited Partnership, dated as of May 31, 2000
IV-3
EXHIBIT FILING
NUMBER REFERENCE DESCRIPTION
- ------- --------- --------------------------------------------------------------------------------------------
10.45 11 Purchase Agreement by and among the Company and Fortress HQ LLC, dated as of May 31,
2000
10.46 11 Purchase Agreement by and among the Company and Stichting Pensioenfonds ABP, dated as
of May 31, 2000
10.47 11 Purchase Agreement by and among the Company and First Union Real Estate Equity and
Mortgage Investments, dated as of May 31, 2000
10.48 11 Purchase Agreement by and among the Company and CIBC WMC Inc., dated as of May 31,
2000
10.49 11 Purchase Agreement by and among the Company and CIBC Employee Private Equity Fund
Partners, dated as of May 31, 2000
10.50 11 Purchase Agreement by and among the Company and AEW Targeted Securities Fund, L.P.,
dated as of May 31, 2000
10.51 11 Purchase Agreement by and among the Company and AEW Targeted Securities Fund II,
L.P., dated as of May 31, 2000
10.52 11 Purchase Agreement by and among the Company and Blackacre Capital Partners, L.P., dated
as of May 31, 2000
10.53 11 Purchase Agreement by and among the Company and Paribas North America, Inc., dated as
of May 31, 2000
10.54 11 Stockholders Agreement by and among the Company, HQ Global Holdings, Inc. and certain
holders of Series A Preferred Stock of HQ Global Holdings, Inc. named therein, dated as of
May 31, 2000
10.55 11 Registration Rights Agreement by and between HQ Global Holdings, Inc. and the investors
named therein, dated as of May 31, 2000
10.56 8 Amended and Restated Credit Agreement among VANTAS, Various Banks, and Paribas, as
agent, dated as of January 16, 1997, as amended and restated as of November 6, 1998 and
August 3, 1999
10.57 18 Amended and Restated Credit Agreement, dated May 31, 2000, among HQ Global Holdings,
Inc., VANTAS Incorporated, Various Banks, ING Capital (U.S.) LLC, Bankers Trust
Company, Citicorp Real Estate, Inc. and BNP Paribas.
10.58 18 Second Amendment and Waiver, dated as of March 26, 2001, among HQ Global Holdings,
Inc., HQ Global Workplaces, Inc., Various Banks, ING Capital (U.S.) LLC, Bankers Trust
Company, Citicorp Real Estate, Inc. and BNP Paribas.
10.59 18 Third Amendment and Agreement, dated as of June 29, 2001, among HQ Global Holdings,
Inc., HQ Global Workplaces, Inc., Various Banks, ING Capital (U.S.) LLC, Bankers Trust
Company, Citicorp Real Estate, Inc. and BNP Paribas.
10.60 19 Forbearance Agreement, dated as of October 1, 2001, among HQ Global Holdings, Inc., a
Delaware corporation, HQ Global Workplaces, Inc., a Delaware corporation, the Subsidiary
Guarantors party thereto, certain Banks party to the Credit Agreement referred to therein,
ING (U.S.) Capital LLC, as managing agent, Bankers Trust Company, as syndication agent
and co-arranger, Citicorp Real Estate, Inc., as documentation agent and co-arranger, and
BNP Paribas, as administrative agent, collateral agent and arranger
10.61 20 Second Amendment to Forbearance Agreement by and among HQ Global Holdings, Inc.,
HQ Global Workplaces, Inc., the Subsidiary Guarantors party thereto, certain Banks party to
the Credit Agreement referred to therein, BNP Paribas, Bankers Trust Company, Citicorp
Real Estate, Inc. and ING (U.S.) Capital LLC
10.62 18 Note and Warrant Purchase Agreement, dated as of August 11, 2000, between HQ Global
Workplaces, Inc., HQ Global Holdings, Inc. and Chase Equity Associates, L.P., CT
Mezzanine Partners I LLC, ARES Leveraged Investment Fund, L.P., Ares Leveraged
Investment Fund II, L.P., Highbridge International LLC, Blackstone Mezzanine Partners L.P.
and Blackstone Mezzanine Holdings.
IV-4
EXHIBIT FILING
NUMBER REFERENCE DESCRIPTION
- ------- --------- ---------------------------------------------------------------------------------------------------
10.63 18 Second Amendment, Agreement and Waiver to Note and Warrant Purchase Agreement,
dated as of June 29, 2001, by and among HQ Global Holdings, Inc., HQ Global Workplaces,
Inc., J.P. Morgan Partners (BHCA) , L.P. (formerly Chase Equity Associates, L.P.), CT
Mezzanine Partners I LLC, Ares Leveraged Investment Fund, L.P., Ares Leveraged
Investment Fund II, L.P., Highbridge International LLC, Blackstone Mezzanine Partners L.P.
and Blackstone Mezzanine Holdings L.P.
10.64 20 Forbearance Agreement and Waiver by and among HQ Global Workplaces, Inc., HQ Global
Holdings, Inc., J.P. Morgan Partners (BHCA), L.P., CT Mezzanine Partners I LLC, Ares
Leveraged Investment Fund, L.P., Ares Leveraged Investment Fund II, L.P., Highbridge
International LLC, Blackstone Mezzanine Partners L.P. and Blackstone Mezzanine Holdings
L.P.
10.65 7 Warrant Registration Rights Agreement, dated December 7, 1999, by and among Reckson
Service Industries, Inc., Elliot S. Cooperstone and H. Thach Pham
10.66 18 Certificate of Designations establishing the rights and preferences of Series A Preferred Stock of
HQ Global Holdings, Inc.
10.67 18 Certificate of Designations establishing the rights and preferences of Series B Preferred Stock of
HQ Global Holdings, Inc.
21.0 Statement of Subsidiaries
23.0 Consent of Independent Auditors
24.0 Powers of Attorney (included in Part IV of this Form 10-K)
- ----------------
(1) Previously filed as an exhibit to Registration Statement on Form S-1
(No.333-44419) and incorporated herein by reference.
(2) Previously filed as an exhibit to the Company's Form 8-K filed with the SEC
on September 11, 1998 and incorporated herein by reference.
(3) Previously filed as an exhibit to the Company's Form 8-K filed with the SEC
on January 25, 1999 and incorporated herein by reference.
(4) Previously filed as an exhibit to the Company's Form 10-K filed with the
SEC on March 31, 1999 and incorporated herein by reference.
(5) Previously filed as an exhibit to the Company's Form 8-K filed with the SEC
on July 16, 1999 and incorporated herein by reference.
(6) Previously filed as an exhibit to Registration Statement on Form S-8 filed
with the SEC on July 29, 1999 and incorporated herein by reference.
(7) Previously filed as an exhibit to the Company's Form 8-K filed with the SEC
on March 28, 2000 and incorporated herein by reference.
(8) Previously filed as an exhibit to the Company's Form 10-K filed with the
SEC on March 29, 2000 and incorporated herein by reference.
(9) Previously filed as an exhibit to Registration Statement on Form S-3
(No.333-34246) and incorporated herein by reference.
(10) Previously filed as an exhibit to the Company's Form 10-Q filed with the
SEC on May 15, 2000 and incorporated herein by reference.
(11) Previously filed as an exhibit to the Company's Form 8-K filed with the SEC
on June 16, 2000 and incorporated herein by reference.
(12) Previously filed as an exhibit to the Company's Form 8-K filed with the SEC
on October 24, 2000 and incorporated herein by reference.
IV-5
(13) Previously filed as an exhibit to the Company's Form 8-K filed with the SEC
on December 15, 2000 and incorporated herein by reference.
(14) Previously filed as an exhibit to the Company's Form 8-K filed with the SEC
on September 1, 1999 and incorporated herein by reference.
(15) Previously filed as an exhibit to the Company's Form 8-K filed with the SEC
on December 13, 1999 and incorporated herein by reference.
(16) Previously filed as an exhibit to the Company's Form 8-K filed with the SEC
on May 12, 2000 and incorporated herein by reference.
(17) Previously filed as an exhibit to the Company's Form 10-K filed with the
SEC on April 2, 2001 and incorporated herein by reference.
(18) Previously filed as an exhibit to the Company's Form 10-Q filed with the
SEC on August 14, 2001 and incorporated herein by reference.
(19) Previously filed as an exhibit to the Company's Form 8-K filed with the SEC
on November 5, 2001 and incorporated herein by reference.
(20) Previously filed as an exhibit to the Company's Form 8-K filed with the SEC
on January 30, 2002 and incorporated herein by reference.
(b) REPORTS ON FORM 8-K
Two reports on Form 8-K were filed during the quarter ended December 31,
2001 as follows:
(i) On October 16, 2001, the Company filed a report on Form 8-K under Item
5 "Other Events" reporting that HQ Global Holdings, Inc. was in default with
respect to certain covenant and payment obligations under its senior and
mezzanine indebtedness.
(ii) On November 5, 2001, the Company filed a report on Form 8-K under Item
5 "Other Events" reporting that HQ Global Holdings, Inc. had entered into a
forbearance agreement with certain banks party to its senior credit agreement. A
copy of the forbearance agreement was filed under Item 7.
IV-6
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized on April 12, 2002.
FRONTLINE CAPITAL GROUP
By: /s/ Scott H. Rechler
-------------------------------------
(Scott H. Rechler)
President, Chief Executive
Officer and Director
KNOW ALL MEN BY THESE PRESENTS, that we, the undersigned officers and directors
of FrontLine Capital Group, hereby severally constitute Scott H. Rechler and
James D. Burnham, and each of them singly, our true and lawful attorneys with
full power to them, and each of them singly, to sign for us and in our names in
the capacities indicated below, the Form 10-K filed herewith and any and all
amendments to said Form 10-K, and generally to do all such things in our names
and in our capacities as officers and directors to enable FrontLine Capital
Group to comply with the provisions of the Securities Exchange Act of 1934, and
all requirements of the Securities and Exchange Commission, hereby ratifying and
confirming our signatures as they may be signed by our said attorneys, or any of
them, to said Form 10-K and any and all amendments thereto.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
NAME TITLE DATE
---- ----- ----
/s/ Scott H. Rechler Chairman of the Board, President, Chief Executive April 12, 2002
- --------------------- Officer and Director (Principal Executive Officer)
(Scott H. Rechler)
/s/ James D. Burnham Chief Financial Officer and Treasurer April 12, 2002
- --------------------- (Chief Accounting Officer)
(James D. Burnham)
/s/ Paul F. Amoruso Director April 12, 2002
- ---------------------
(Paul F. Amoruso)
/s/ Sidney Braginsky Director April 12, 2002
- ---------------------
(Sidney Braginsky)
/s/ Ronald S. Cooper Director April 12, 2002
- ---------------------
(Ronald S. Cooper)
/s/ Douglas A. Sgarro Director April 12, 2002
- ---------------------
(Douglas A. Sgarro)
IV-7
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
FrontLine Capital Group
We have audited the accompanying consolidated balance sheets of FrontLine
Capital Group and Subsidiaries as of December 31, 2001 and 2000, and the related
consolidated statements of operations, shareholders' (deficiency) equity, and
cash flows for each of the three years in the period ended December 31, 2001.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of FrontLine
Capital Group and Subsidiaries at December 31, 2001 and 2000, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 2001, in conformity with accounting
principles generally accepted in the United States.
The accompanying consolidated financial statements have been prepared
assuming that FrontLine Capital Group will continue as a going concern. As more
fully described in Note 1, the Company has incurred recurring operating losses
and has a working capital deficiency. In addition, the Company is in default,
has not complied with certain covenants of its loan agreements and on March 13,
2002 its principal subsidiary HQ Global Holdings, Inc. and certain of its
affiliates filed voluntary petitions for relief under Chapter 11 of Title 11 of
the United States Bankruptcy code. These conditions raise substantial doubt
about the Company's ability to continue as a going concern. Management's plans
in regard to these matters are also described in Note 1. The financial
statements do not include any adjustments to reflect the possible future effects
on the recoverability and classification of assets or the amounts and
classification of liabilities that may result from the outcome of this
uncertainty.
ERNST & YOUNG LLP
New York, New York
March 13, 2002,
except for Note 17,
as to which the date
is April 10, 2002
IV-8
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
DECEMBER 31,
--------------------------
2001 2000
---- ----
ASSETS:
Current Assets:
Cash and cash equivalents ......................................... $ 18,139 $ 19,665
Restricted cash ................................................... 878 5,768
Accounts receivable, net of allowance for doubtful accounts of
$2,492 and $3,393 at December 31, 2001 and 2000, respectively
(Note 2) ........................................................ 6,865 31,988
Other current assets .............................................. 4,502 29,398
---------- ----------
Total Current Assets ............................................ 30,384 86,819
Ownership interests in and advances to unconsolidated companies
(Note 4) .......................................................... 13,396 39,845
Intangible assets, net (Note 6) .................................... 16,820 581,680
Property and equipment, net (Note 5) ............................... 168,486 202,005
Deferred financing costs, net ...................................... 40,274 48,875
Net assets from discontinued operations (Note 3) ................... 5,500 140,345
Other assets, net .................................................. 5,908 19,883
---------- ----------
TOTAL ASSETS .................................................... $ 280,768 $1,119,452
========== ==========
LIABILITIES AND SHAREHOLDERS' (DEFICIENCY) EQUITY:
Current Liabilities:
Accounts payable and accrued expenses (Note 7) .................... $ 61,220 $ 60,382
Accrued restructuring costs ....................................... 51,567 --
Credit facilities with related parties (Note 15) .................. 176,909 --
Current portion of senior secured debt (Note 9) ................... -- 32,999
Notes payable (Note 9) ............................................ 366,506 25,000
Deferred rent payable ............................................. 3,345 2,713
Other current liabilities ......................................... 988 2,558
---------- ----------
Total Current Liabilities ....................................... 660,535 123,652
Credit facilities with related parties (Note 15) ................... -- 135,523
Senior secured debt (Note 9) ....................................... -- 179,926
Subordinated notes payable (Note 9) ................................ -- 125,000
Deferred rent payable .............................................. 49,102 38,562
Other liabilities .................................................. 50,496 76,429
---------- ----------
TOTAL LIABILITIES ............................................... 760,133 679,092
---------- ----------
MINORITY INTEREST .................................................. -- 305,577
REDEEMABLE CONVERTIBLE PREFERRED STOCK (AGGREGATE LIQUIDATION
PREFERENCE $25,000 AT DECEMBER 31, 2001 AND $15,000 AT
DECEMBER 31, 2000) (NOTE 10) ...................................... 25,325 13,940
COMMITMENTS AND CONTINGENCIES ...................................... -- --
SHAREHOLDERS' (DEFICIENCY) EQUITY (NOTE 11):
8.875% convertible cumulative preferred stock, $.01 par value,
25,000,000 shares authorized, 26,000 issued and outstanding, at
December 31, 2001 and 2000 ...................................... -- --
Common stock, $.01 par value, 100,000,000 shares authorized,
37,344,039 and 36,625,847 shares issued and outstanding at
December 31, 2001 and 2000, respectively ........................ 373 366
Additional paid-in capital ........................................ 400,793 400,916
Accumulated deficit ............................................... (905,856) (281,030)
Accumulated other comprehensive income ............................ -- 591
---------- ----------
TOTAL SHAREHOLDERS' (DEFICIENCY) EQUITY ......................... (504,690) 120,843
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' (DEFICIENCY) EQUITY ......... $ 280,768 $1,119,452
========== ==========
See accompanying notes to consolidated financial statements.
IV-9
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
YEAR ENDED DECEMBER 31,
---------------------------------------------
2001 2000 1999
------------- ------------- -------------
HQ OPERATING REVENUES:
Workstation revenue ................................................. $ 310,520 $ 279,561 $ 129,026
Support services .................................................... 160,187 175,929 85,419
----------- ----------- -----------
TOTAL HQ OPERATING REVENUES ....................................... 470,707 455,490 214,445
----------- ----------- -----------
HQ OPERATING EXPENSES:
Rent ................................................................ 219,826 170,334 87,775
Support services .................................................... 58,055 53,610 26,345
Center general and administrative ................................... 107,641 93,263 54,839
General and administrative .......................................... 60,831 50,436 17,959
----------- ----------- -----------
TOTAL HQ OPERATING EXPENSES ....................................... 446,353 367,643 186,918
----------- ----------- -----------
HQ OPERATING INCOME ............................................... 24,354 87,847 27,527
----------- ----------- -----------
HQ OTHER EXPENSES:
Impairment of assets ................................................ (561,196) -- --
Depreciation and amortization (Note 2) .............................. (70,102) (51,368) (15,004)
Restructuring costs ................................................. (57,553) -- --
Interest expense, net ............................................... (44,387) (32,303) (10,199)
Merger and integration costs (Note 12) .............................. -- (24,701) (26,730)
----------- ----------- -----------
HQ Loss from Continuing Operations ................................ (708,884) (20,525) (24,406)
Parent Expenses:
General and administrative expenses ................................. (3,915) (16,478) (9,509)
Amortization of deferred charges .................................... (2,274) (14,330) (8,455)
Restructuring costs (Note 13) ....................................... (11,490) (12,788) --
Interest expense, net ............................................... (22,389) (18,903) (8,166)
Depreciation and amortization ....................................... -- (1,123) (676)
Development stage company costs ..................................... -- (9,999) --
----------- ----------- -----------
LOSS FROM CONTINUING OPERATIONS BEFORE INCOME TAXES, MINORITY
INTEREST AND EQUITY IN NET LOSS AND IMPAIRMENT OF
UNCONSOLIDATED COMPANIES ......................................... (748,952) (94,146) (51,212)
(Provision for) benefit from income taxes (Note 8) ................... (792) (3,439) 2,841
Minority interest .................................................... 305,984 (7,688) 18,790
Equity in net loss and impairment of unconsolidated companies
(Note 4) ............................................................ (36,448) (125,928) (10,266)
----------- ----------- -----------
LOSS BEFORE DISCONTINUED OPERATIONS AND EXTRAORDINARY ITEM
FROM EARLY EXTINGUISHMENT OF DEBT ................................ (480,208) (231,201) (39,847)
Income (loss) from discontinued operations (Note 3) .................. (144,618) 1,071 --
----------- ----------- -----------
LOSS BEFORE EXTRAORDINARY ITEM FROM EARLY EXTINGUISHMENT OF
DEBT ............................................................. (624,826) (230,130) (39,847)
Extraordinary item from early extinguishment of debt ................. -- (2,648) --
----------- ----------- -----------
NET LOSS .......................................................... (624,826) (232,778) (39,847)
Dividends on and accretion of preferred stock ........................ (5,582) (2,119) --
----------- ----------- -----------
Net loss applicable to common shareholders ........................ $ (630,408) $ (234,897) $ (39,847)
=========== =========== ===========
Basic and diluted net loss per weighted average common share ......... $ (17.03) $ (6.73) $ (1.56)
=========== =========== ===========
Basic and diluted weighted average common shares outstanding ......... 37,009,891 34,880,709 25,600,985
=========== =========== ===========
See accompanying notes to consolidated financial statements.
IV-10
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' (DEFICIENCY) EQUITY
(IN THOUSANDS)
ACCUMULATED TOTAL
ADDITIONAL OTHER SHAREHOLDERS'
COMMON PAID-IN ACCUMULATED COMPREHENSIVE (DEFICIENCY)
STOCK CAPITAL DEFICIT INCOME EQUITY
-------- ------------ ------------- --------------- --------------
SHAREHOLDERS' EQUITY, JANUARY 1, 1999 ............. $247 $ 24,126 $ (8,405) $ -- $ 15,968
Issuance of common stock ......................... 44 71,923 -- -- 71,967
Proceeds from the exercise of employee stock
options ........................................ 2 274 -- -- 276
Issuance of warrants ............................. -- 2,172 -- -- 2,172
Proceeds from public offering, net of costs of
$4,348.......................................... 14 63,559 -- -- 63,573
Net loss ......................................... -- -- (39,847) -- (39,847)
---- -------- ---------- ------ ----------
SHAREHOLDERS' EQUITY, DECEMBER 31, 1999 ........... 307 162,054 (48,252) -- 114,109
Issuance of common stock ......................... 31 66,019 -- -- 66,050
Issuance of common stock and warrants in a
public offering, net of costs of $6,667......... 26 115,920 -- -- 115,946
Issuance of preferred stock, net ................. -- 24,459 -- -- 24,459
Proceeds from the exercise of employee stock
options ........................................ 2 1,163 -- -- 1,165
Issuance of warrants ............................. -- 33,420 -- -- 33,420
Dividends on and accretion of redeemable
preferred stock ................................ -- (2,119) -- -- (2,119)
Unrealized gain on marketable equity
securities ..................................... -- -- -- 591 591
Net loss ......................................... -- -- (232,778) -- (232,778)
---- -------- ---------- ------ ----------
SHAREHOLDERS' EQUITY, DECEMBER 31, 2000 ........... 366 400,916 (281,030) 591 120,843
Proceeds from the exercise of employee stock
options ........................................ 7 1,615 -- -- 1,622
Dividends on and accretion of redeemable
preferred stock ................................ -- (1,738) -- -- (1,738)
Unrealized gain on marketable equity
securities ..................................... -- -- -- (591) (591)
Net loss ......................................... -- -- (624,826) -- (624,826)
---- -------- ---------- ------ ----------
SHAREHOLDERS' (DEFICIENCY) EQUITY, DECEMBER 31,
2001 ............................................. $373 $400,793 $ (905,856) $ -- $ (504,690)
==== ======== ========== ====== ==========
See accompanying notes to consolidated financial statements.
IV-11
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
-----------------------------------------------
2001 2000 1999
-------------- -------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Loss from continuing operations ...................................... $ (480,208) $ (233,849) $ (39,847)
Adjustments to reconcile loss from continuing operations to cash
provided by (used in) operating activities:
Depreciation and amortization ...................................... 70,102 52,491 15,680
Impairment of assets ............................................... 561,196 -- --
Amortization of deferred financing costs ........................... 8,908 5,720 719
Extraordinary loss on early extinguishment of debt ................. -- 2,648 --
Equity in net loss and impairment of unconsolidated companies....... 36,448 125,928 10,266
Minority interest .................................................. (305,984) 7,688 (18,790)
Deferred income taxes .............................................. -- -- (3,541)
Stock and related compensation ..................................... 2,076 15,188 30,493
Non-cash restructuring costs ....................................... 59,795 8,875 --
Changes in operating assets and liabilities:
Accounts receivable, net .......................................... 25,123 (19,801) (1,328)
Acquisition costs and other assets ................................ 11,200 17,240 (7,251)
Deferred rent payable ............................................. 9,896 16,455 6,024
Accounts payable and accrued expenses ............................. (3,374) (40,754) 19,834
Accrued restructuring costs ....................................... (6,094) -- --
Other liabilities ................................................. 8,782 16,575 88
Affiliate receivables ............................................. -- -- 7,759
---------- ---------- ----------
Net cash provided by (used in) operating activities from
continuing operations .......................................... (2,134) (25,596) 20,106
Net cash provided by discontinued operations ..................... 14,423 1,397 --
---------- ---------- ----------
Net cash provided by (used in) operating activities .............. 12,289 (24,199) 20,106
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions of officing solutions centers, net of cash proceeds ..... -- (323,653) (47,329)
Equipment ............................................................ (35,381) (60,741) (41,882)
Restricted cash ...................................................... 4,890 22,866 (10,318)
Proceeds from sale of short-term investments ......................... 20,918 -- --
Acquisition of ownership interests and advances to unconsolidated
companies .......................................................... (10,426) (68,322) (132,332)
---------- ---------- ----------
Net cash used in continuing investing activities ................. (19,999) (429,850) (231,861)
Net cash used by discontinued operations ......................... (12,011) (2,746) --
---------- ---------- ----------
Net cash used in investing activities ............................ (32,010) (432,596) (231,861)
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock and warrants, net of costs .................. -- 156,957 60,812
Issuance of preferred stock and redeemable preferred stock, net of
costs .............................................................. 10,000 38,510 --
Deferred financing costs ............................................. -- (27,161) (4,398)
Net change in credit facilities with related parties ................. 6,538 13,675 128,492
Capital leases ....................................................... (1,984) (2,657) (2,226)
Net repayments of secured credit facility and notes payable .......... 3,581 55,615 44,407
Net proceeds from minority interest .................................. (366) 208,193 8,642
Other, net ........................................................... 426 588 3,125
---------- ---------- ----------
Net cash provided by financing activities ........................ 18,195 443,720 238,854
---------- ---------- ----------
Cash and Cash Equivalents:
Net (decrease) increase .............................................. (1,526) (13,075) 27,099
Beginning of period .................................................. 19,665 32,740 5,641
---------- ---------- ----------
End of period ........................................................ $ 18,139 $ 19,665 $ 32,740
========== ========== ==========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest ........................................................... $ 11,833 $ 58,245 $ 14,253
========== ========== ==========
Income taxes ....................................................... $ 1,554 $ 1,499 $ 2,009
========== ========== ==========
See accompanying notes to consolidated financial statements.
IV-12
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999, 2000, 2001
1. BASIS OF PRESENTATION
ORGANIZATION AND BUSINESS
FrontLine Capital Group ("FrontLine" or the "Company") is a holding
company, with two distinct operating segments: one holds FrontLine's interest in
HQ Global Workplaces, Inc., a company in the officing solutions market (see Note
3 for further discussion) and its predecessor companies ("HQ" or the "HQ Global
Segment"), and the other consists of FrontLine (parent company) ("FrontLine
Parent") and its interests in a group of companies (the "Parent and Other
Interests Segment") that provide a range of services. In October 2000, FrontLine
announced that it would focus its resources and capital on the businesses within
its existing portfolio and cease pursuing new investment activities.
HQ GLOBAL BANKRUPTCY
On March 13, 2002, HQ filed a voluntary petition for relief under Chapter
11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the District of
Delaware and received a commitment for $30 million in debtor-in-possession
financing (see Note 3).
NOTES PAYABLE, CREDIT FACILITIES AND PREFERRED STOCK DEFAULTS
As of December 31, 2001, the Company has not paid certain principal and
interest due on the FrontLine Bank Credit Facility and both the FrontLine Bank
Credit Facility (See Note 9) and the Credit Facilities with Reckson Operating
Partnership, L.P. ("Reckson") (See Note 15) are in default. Additionally, the
Company did not pay the dividend that became payable on December 31, 2001 for
the Redeemable Preferred Stock, and is in default under that agreement (see Note
10).
The accompanying consolidated financial statements have been prepared on a
going concern basis of accounting and do not reflect any adjustments that might
result should the Company be unable to continue as a going concern. The
Company's inability to repay or refinance its indebtedness when due, and pay
dividends on its redeemable preferred stock, its recent losses from operations
and the related Chapter 11 proceeding of HQ raise concern about its ability to
continue as a going concern. The appropriateness of using the going concern
basis is dependent upon, among other things (i) confirmation of a plan of
reorganization of HQ under the Bankruptcy Code, (ii) the ability to achieve
profitable operations after such confirmation and (iii) the ability to generate
sufficient cash from operations and through asset sales to meet its obligations.
FrontLine is in default of its debt agreement and has insufficient cash
reserves to continue operations for the next twelve months. Although
negotiations are ongoing, it does not appear likely that a satisfactory
restructuring of these obligations will be achieved. Accordingly, the Company is
currently considering its future options, including seeking protection from its
creditors under the federal bankruptcy laws.
DELISTING BY NASDAQ
In March 2002, the Company's stock was delisted by Nasdaq as a direct
result of the HQ bankruptcy filing. The Company's common stock currently trades
on the OTC Bulletin Board under the symbol FLCGQ.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying consolidated financial statements present the consolidated
financial position of the Company and its majority-owned subsidiaries. The
financial position, results of operations and cash flows of the HQ Global
Segment are presented in Note 3. The financial position, results of operations
and cash flows of the Parent and Other Interests Segment are summarized in Note
4. All significant intercompany balances and transactions have been eliminated
in the consolidated financial statements.
IV-13
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999, 2000, 2001 - (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
ACCOUNTING FOR OWNERSHIP INTERESTS
The interests that FrontLine owns are accounted for under one of three
methods: consolidation, equity method and cost method. The applicable accounting
method is generally determined based on the Company's voting interest and rights
in each investee.
Consolidation. Entities in which the Company directly or indirectly owns
more than 50% of the outstanding voting securities or controls the board of
directors are generally accounted for under the consolidation method of
accounting. Under this method, an investee's results of operations are reflected
within the Company's Consolidated Statements of Operations. Participation of
other (non-FrontLine) shareholders in the earnings or losses of a consolidated
company is reflected in the caption "Minority interest" in the Company's
Consolidated Statements of Operations. Minority interest adjusts the Company's
consolidated results of operations to reflect only the Company's share of the
earnings or losses of the consolidated company.
Equity Method. Investees whose results are not consolidated, but over whom
the Company exercises significant influence, are accounted for under the equity
method of accounting. Under the equity method of accounting, an investee's
accounts are not reflected within the Company's Consolidated Statements of
Operations; however, FrontLine's share of the earnings or losses of the investee
is reflected in the caption "Equity in net loss and impairment of unconsolidated
companies" in the accompanying Consolidated Statements of Operations.
Cost Method. Investees not accounted for under the consolidation or the
equity method of accounting, which are generally those in which the Company has
less than a 20% interest in the voting securities of the investee, are accounted
for under the cost method of accounting. Under this method, the Company's share
of the earnings or losses of such companies is not included in the Consolidated
Statements of Operations.
IV-14
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999, 2000, 2001 - (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
CASH AND CASH EQUIVALENTS
The Company considers highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents.
HQ's and FrontLine's cash balances are each held primarily at one financial
institution and may, at times, exceed insurable amounts. The Company believes it
mitigates its risk by investing in or through a major financial institution.
MARKETABLE EQUITY SECURITIES
Available-for-sale marketable equity securities are reported at fair market
value, with the resulting net unrealized gain or loss reported within
shareholders' equity.
RECEIVABLES
HQ licenses office space and provides support services to clients in
various industries, ranging in size from small entrepreneurial entities to local
offices of international corporations. HQ's facilities included in continuing
operations are primarily located in the United States, which limits its exposure
to certain economic risks based upon local economic conditions. HQ performs
credit evaluations of its clients and generally requires approximately two
months' charges as a service retainer. HQ records an allowance for doubtful
accounts which reflects management's estimate of the risk of uncollectible
accounts receivable.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
The following represents the activity in HQ's allowance for doubtful
accounts for the years ended December 31, 2001, 2000 and 1999 (in thousands):
YEAR ENDED DECEMBER 31,
--------------------------------------
2001 2000 1999
------------ ----------- ---------
Balance at beginning of period ......... $ 3,393 $ 861 $ 401
Charged to cost and expenses ........... 9,684 3,050 1,291
Recorded in the HQ Merger .............. -- 1,335 --
Accounts written off ................... (10,585) (1,853) (831)
--------- -------- ------
Balance at end of period ............... $ 2,492 $ 3,393 $ 861
========= ======== ======
PROPERTY AND EQUIPMENT
Property and equipment consists primarily of property and equipment owned
by HQ, and is stated at cost less accumulated depreciation and amortization.
Effective January 1, 1999, the Company adopted Statement of Position ("SOP")
98-1, Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use, which requires the capitalization of certain costs incurred in
connection with developing or obtaining internal use software. During 2001 and
2000, HQ capitalized $1.5 million and $5.7 million, respectively, related to the
development of its enterprise resource system.
Office equipment, furniture and fixtures are depreciated using the
straight-line method over the estimated useful lives of the assets, which range
from three to seven years. The cost of HQ's enterprise resource system is being
amortized over seven years. Leasehold improvements are amortized over the lesser
of the term of the related lease or the estimated useful lives of the assets.
IV-15
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999, 2000, 2001 - (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
DEFERRED FINANCING COSTS
The Company amortizes deferred financing costs over the term of the related
debt. As of December 31, 2001 and 2000, accumulated amortization was $16.0
million and $7.1 million, respectively. Amortization of deferred financing costs
is included as a component of interest expense in the accompanying consolidated
statement of operations.
INTANGIBLE ASSETS
Intangible assets consist primarily of goodwill representing the excess of
the purchase price over the net assets of VANTAS Incorporated ("VANTAS") and HQ.
Goodwill is amortized using the straight-line method. In connection with the
merger of HQ and VANTAS (see Note 3), the Company reassessed the estimated life
of goodwill resulting from the merger. As a result, the amortization period for
goodwill was reduced from 30 to 20 years, resulting in additional amortization
expense of $2.1 million for the year ended December 31, 2000.
IMPAIRMENTS OF OWNERSHIP INTERESTS AND ADVANCES TO UNCONSOLIDATED COMPANIES
The Company continually evaluates the carrying value of its ownership
interests in and advances to each of its investments in unconsolidated companies
for possible impairment based on achievement of business plan objectives and
milestones, the value of each ownership interest in the unconsolidated company
relative to carrying value, the financial condition and prospects of the company
and other relevant factors. The fair value of the Company's ownership interests
in and advances to privately held companies is generally determined based on the
value at which independent third parties have invested or have committed to
invest in the companies. The Company recorded a $25.7 million charge during the
year ended December 31, 2000 to recognize impairment charges to reduce the
carrying value of its investments in certain unconsolidated companies. In
recognition of continuing difficult capital market conditions and operating
performance of these ownership interests, the Company recorded an additional
$32.9 million during the year ended December 31, 2001. Of the $32.9 million
recorded, $20.0 million related to Reckson Strategic Venture Partners, LLC
("Reckson Strategic")(see Note 4 for further discussion). These charges are
included in "Equity in net loss and impairment of unconsolidated companies" in
the accompanying Consolidated Statements of Operations.
IMPAIRMENTS OF LONG-LIVED ASSETS
The Company reviews long-lived assets, including intangible assets, for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by a comparison of the carrying amount of an asset
to the estimated fair value of the asset or business center. In preparing these
estimates, HQ must make a number of assumptions concerning occupancy rates,
rates which will be charged to clients for workstations and services, and rates
of growth of rent expense and other operating expenses. If such assets are
considered to be impaired, the impairment to be recognized is measured by the
amount by which the carrying amount of the assets exceeds the estimated fair
value of the assets.
Impairment charges are recorded as a permanent reduction in the carrying
amount of the related asset. Based on the trend of operating losses as well as
HQ's inability to remain in compliance with its debt arrangements, HQ determined
that the carrying value of its intangible assets was impaired at September 30,
2001. Therefore, in the third quarter of 2001, the Company recognized an
impairment charge of approximately $294.1 million, representing the amount by
which the carrying amount of the
IV-16
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999, 2000, 2001 - (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
intangible assets exceeded their estimated fair value. As a result of continuing
operating losses, the Company further revised its projected cash flows during
the fourth quarter of 2001, resulting in an additional impairment charge of
$241.4 million. Management believes that assumptions made in estimating fair
values were reasonable, but actual fair values may differ significantly from
these estimates.
Assets to be disposed of are reported at the lower of the carrying amount
or estimated fair value less costs to sell. Accordingly, HQ has recorded an
impairment charge of $25.7 million related to the restructuring program (see
Note 14).
NEW PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statements of Financial Accounting Standards ("FAS") No. 141, Business
Combinations, ("FAS 141"), and No. 142, Goodwill and Other Intangible Assets,
("FAS 142"), effective for fiscal years beginning after December 15, 2001. Under
the new rules, goodwill and intangible assets deemed to have indefinite lives
will no longer be amortized, but will be subject to annual impairment tests in
accordance with the Statements. Other intangible assets will continue to be
amortized over their useful lives.
The Company will apply the new rules on accounting for goodwill and other
intangible assets beginning in the first quarter of 2002. Amortization of
goodwill and other intangible assets recorded in connection with business
combinations totaled approximately $27.6 million, $20.4 million and 6.1 million
during the years ended December 31, 2001, 2000 and 1999 respectively. As a
result of impairment charges recorded in the third and fourth quarters of 2001,
the Company does not have any recorded goodwill or indefinite lives of
intangible assets at December 31, 2001. Accordingly, adoption of FAS 142 will
not have an impact on the Company's financial condition or results of
operations. Intangible assets with a carrying value of approximately $16.8
million at December 31, 2001 will continue to be amortized after adoption of FAS
142.
The FASB has also recently issued FAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets ("FAS 144"), which will be adopted
by the Company on January 1, 2002. The FASB's new rules on asset impairment
supersede FAS No. 121, Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of ("FAS 121"). FAS 144 retains the
requirements of FAS 121 to (a) recognize an impairment loss only if the carrying
amount of a long-lived asset is not recoverable from its undiscounted cash flows
and (b) measure an impairment loss as the difference between the carrying amount
and fair value of the asset, but removes goodwill from its scope. This aspect of
FAS 144 will primarily impact the accounting for intangible assets subject to
amortization, property and equipment, and certain other long-lived assets. The
Company does not believe that the effect of the adoption of FAS 144 will have a
significant impact on its financial condition or results of operations.
REVENUE RECOGNITION
The Company's operating revenues for all periods presented were
attributable to HQ. Revenues from workstations and business services are
recognized as the related services are provided. Workstation revenues consist of
office and related furniture rental, parking and storage. Business services
consist of (1) technology services comprised of Internet, videoconferencing and
telecommunications services and (2) other business services which include
charges to clients that do not require offices on a full-time basis, conference
and training room usage, catering, copies, management and franchise fees.
FRANCHISE FEES
As a result of the HQ Merger, HQ became a franchiser of 46 domestic and 30
international business centers operated by unrelated franchisees. Subsequent to
the HQ merger, 5 domestic and 1 international franchise center have been added
to HQ's network. The financial results of franchised locations are not
IV-17
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999, 2000, 2001 - (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
included in the consolidated results of the Company. HQ charges a franchise fee
for use of its brand name and marketing support, which is recorded in the period
earned. Franchise fees aggregated $1.5 million and $1.8 million for the years
ended December 31, 2001 and 2000, respectively and are included in business
service revenues.
RENT EXPENSE
Payments under operating leases are recognized as rent expense on a
straight-line basis over the term of the related lease. The difference between
the rent expense recognized for financial reporting purposes and the actual
payments made in accordance with the lease agreements is recognized as a
deferred rent liability. Rent expense charged to operations for the years ended
December 31, 2001, 2000 and 1999, exceeded actual rental payments by $9.0
million, $9.2 million and $6.0 million, respectively.
During the years ended December 31, 2001, 2000 and 1999, the Company
recorded deferred credits relating to tenant improvements which are reimbursed
or paid by landlords and amortized against rent expense over the life of the
leases, of $3.9 million, $8.9 million and $11.8 million, respectively. As of
December 31, 2001 and 2000, the deferred rent liability includes approximately
$26.0 million and $21.3 million, respectively, representing the unamortized
balances of such deferred credits.
The estimated fair value of favorable lease rates on business centers
acquired in the HQ Merger (see Note 3) is being amortized over the terms of the
respective leases acquired. At December 31, 2001, the weighted average remaining
term of these leases was 8.5 years.
HQ DEPRECIATION AND AMORTIZATION
Depreciation and amortization of the HQ Segment consists of the following
(in thousands):
YEAR ENDED DECEMBER 31,
-----------------------------------
2001 2000 1999
---------- ---------- ---------
Property and equipment ............................ $42,538 $28,279 $ 8,738
Goodwill .......................................... 25,164 21,359 6,101
Favorable acquired business center leases ......... 2,400 1,400 --
Other intangible assets ........................... -- 330 165
------- ------- -------
$70,102 $51,368 $15,004
======= ======= =======
STOCK-BASED COMPENSATION
The Company follows Accounting Principles Board Opinion No. 25 (APB 25),
Accounting for Stock Issued to Employees, and related interpretations in
accounting for its employee stock options. The Company accounts for stock-based
compensation for non-employees under the fair value method prescribed by
Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation ("FAS 123"). Through December 31, 2001, there have been no
significant grants to non-employees.
Effective July 1, 2000, the Company adopted Interpretation No. 44,
Accounting for Certain Transactions Involving Stock Compensation ("FIN 44"), an
interpretation of APB 25, which requires changes to previous practice regarding
the accounting for certain stock compensation arrangements. FIN 44 does not
change APB 25's intrinsic value method, under which compensation expense is
generally not recognized for grants of stock options to employees with an
exercise price equal to the market price of the stock at the date of grant, but
it has narrowed its application. Adoption of FIN 44 did not have a significant
effect on the Company's results of operations for the year ended December 31,
2001 and 2000.
IV-18
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999, 2000, 2001 - (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
COMPREHENSIVE LOSS
Comprehensive income (loss) is defined as the change in equity of a
business enterprise during a period from transactions, events and circumstances
from non-owner sources. It includes all changes in equity during a period except
those resulting from investments by owners and distributions to owners. During
the year ended December 31, 2001, the difference between net loss ($624,826,000)
and total comprehensive loss ($624,235,000) was due to realized gains on
"available-for-sale" marketable securities.
SEGMENT REPORTING
The segment information required by SFAS No. 131, "Disclosure about
Segments of an Enterprise and Related Information," relating to the HQ Segment
and the Parent and Other Interests Segment is presented in Notes 3 and 4,
respectively.
Each of the segments has a FrontLine senior professional assigned for
purposes of monitoring performance and carrying out operating activity. These
professionals report directly to the Chief Executive Officer and Treasurer, who
along with the Board of Directors have been identified as the Chief Operating
Decision Makers ("CODM") because of their final authority over resource
allocation decisions and performance assessment.
FrontLine's governance and control rights are generally exercised through
Board of Directors seats and through representation on the executive committees
of its investee entities.
FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures About Fair Value of Financial Instruments"
requires the Company to disclose the estimated fair values of its financial
instrument assets and liabilities. The carrying amounts approximate fair value
for cash and cash equivalents, restricted cash, accounts receivable, accounts
payable and accrued expenses because of the short maturity of those instruments.
Other than as disclosed in Notes 9 and 15, the estimated fair values of the
Company's long-term debt approximate the recorded balances.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The Company adopted the provision of SFAS No. 133 ("SFAS 133") "Accounting
for Derivatives and Hedging Activities," as amended, effective January 1, 2001.
SFAS 133 requires the Company to recognize all derivatives on the balance sheet
at fair value. Derivatives that are not hedges must be adjusted to fair value
through income. If the derivative is a hedge, depending on the nature of the
hedge, changes in the fair value of derivatives will either be offset against
the change in fair value of the hedged assets, liabilities, or firm commitments
IV-19
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999, 2000, 2001 - (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
through earnings or recognized in other comprehensive income until the hedged
item is recognized in earnings. The ineffective portion of a derivative's change
in fair value will be immediately recognized in earnings.
HQ enters into contracts that establish a cap and a floor interest rate on
notional amounts to hedge the interest rate risk on its floating-rate debt. The
Company's policy is that it will not speculate in hedging activities. The effect
of adopting FAS 133 as of January 2001 was not material to the Company's results
of operations. There were no derivatives outstanding at December 31, 2001.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. The most significant assumptions and
estimates relate to the lives and recoverability of long-lived assets. Actual
results could differ from those estimates.
RISK AND UNCERTAINTIES
The future results of operations and financial condition of HQ will be
impacted by the following factors, among others: the competition in the office
solutions business with respect to, among other things, price, service, and
location; dependence on leases and changes in lease costs; the availability of
capital for expansion; the ability to obtain and retain qualified employees; the
level of difficulty experienced in the integration of acquired businesses; the
competition for future acquisitions; and the ability of HQ to secure adequate
capital.
RECLASSIFICATIONS
Certain prior period amounts and segment disclosures have been reclassified
to conform to the current year presentation.
3. INTEREST IN HQ GLOBAL AND PREDECESSOR ENTITIES
VANTAS AND PREDECESSOR ENTITIES
On January 8, 1999, InterOffice Superholdings Corporation ("InterOffice")
(36 executive office suite centers) and Reckson Executive Centers, Inc.
("Reckson Executive") (8 executive office suite centers) merged with Alliance
National Incorporated, a holding company which owned and operated approximately
90 nationally located executive office suite centers (the "VANTAS Merger"). To
effectuate the VANTAS Merger, the Company contributed approximately $21.4
million of assets represented by the assets of InterOffice and Reckson
Executive, which were acquired by FrontLine in 1998. The merged entity changed
its name to VANTAS. The stockholders of InterOffice and Reckson Executive
received 13,325,424 shares of convertible Series C Preferred Stock of VANTAS
valued at $63.3 million representing approximately 40% of the equity interest in
VANTAS of which approximately 23% was received by the Company.
In addition to the VANTAS Merger described above, VANTAS acquired 42
business centers, in 11 acquisitions, for an aggregate purchase price of $43.6
million in cash during the year ended December 31, 1999. The VANTAS Merger and
these acquisitions (collectively, the "1999 Mergers") were recorded using the
purchase method of accounting and are included in operations from the date of
acquisition. The aggregate cost of the 1999 Mergers consisted of the following
(in thousands):
IV-20
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999, 2000, 2001 - (CONTINUED)
3. INTEREST IN HQ GLOBAL AND PREDECESSOR ENTITIES - (CONTINUED)
Cash paid to former owners, net of cash received ......... $ 38,096
VANTAS Series C Preferred Stock .......................... 63,296
Transaction costs ........................................ 7,088
--------
$108,480
========
The costs of the 1999 Mergers have been allocated to the respective assets
acquired and liabilities assumed, with the remainder recorded as goodwill as
follows (in thousands):
Working capital .......................................... $ 4,618
Goodwill ................................................. 115,968
Other assets ............................................. 2,984
Other non current liabilities ............................ (16,063)
Deferred income taxes .................................... 973
---------
$ 108,480
=========
As of December 31, 1999, VANTAS operated 201 business centers in 27 states,
the District of Columbia, France and Mexico and managed 5 other centers for
unrelated property owners. VANTAS provided fully furnished individual offices
and suites and a full range of telecommunication and business support services
to clients that generally required 2,000 square feet or less of traditional
office space. VANTAS did not own the real estate in which the business centers
were located.
As a result of the step acquisition during 1999 of a controlling interest
in VANTAS, the Company changed the accounting method for its investment in
VANTAS from the equity method to the consolidation method during the fourth
quarter of 1999 and retroactively restated all 1999 quarters. During the third
quarter of 1999, the Company increased its ownership in VANTAS to approximately
35% on a basic basis and 29% on a diluted basis through the acquisition of an
additional $23.0 million equity ownership interest in VANTAS as a part of a
$30.0 million financing by VANTAS. Subsequently, the Company entered into stock
purchase agreements with other VANTAS stockholders to increase its ownership to
approximately 84% on a basic basis and 76% on a diluted basis. The terms to
acquire these VANTAS shares were generally to pay 70% of the purchase price in
cash and the remaining 30% in FrontLine stock, which at the time had a value of
$19.00 per share. The closings for these transactions took place periodically
from November 30, 1999 and were completed during the first quarter of 2000. As
of December 31, 1999, the Company had expended approximately $59.8 million in
cash and issued 1,828,099 shares of its common stock. In closings during the
first quarter of 2000, the Company paid approximately $43.3 million in cash and
issued 1,294,103 shares of its common stock.
MERGER WITH HQ
On June 1, 2000, VANTAS merged with HQ Global Workplaces, Inc. ("Old HQ"),
in a two-step merger, and HQ Global also acquired two other entities involved in
the executive office suites business outside the United States (the "HQ
Merger"). As a result of the HQ Merger, the combined company, under the name HQ
Global Workplaces, Inc., became a wholly-owned subsidiary of a newly-formed
parent corporation, HQ Global. The HQ Merger was financed through a combination
of debt and HQ Global preferred stock and warrants. As of December 31, 2000,
FrontLine's ownership interest was 56.5% on a basic basis. Although FrontLine's
percentage ownership may vary depending on the actual preferred stock conversion
price, on a fully-diluted basis, assuming the outstanding preferred stock
converted at the HQ Merger conversion price, and including certain warrants to
purchase HQ Global stock, FrontLine would own approximately 38% of the common
stock of HQ Global. To effectuate the HQ Merger, FrontLine contributed
approximately $17 million in cash and its ownership interest in VANTAS.
IV-21
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999, 2000, 2001 - (CONTINUED)
3. INTEREST IN HQ GLOBAL AND PREDECESSOR ENTITIES - (CONTINUED)
The costs of the HQ Merger have been allocated to the respective assets
acquired and liabilities assumed, with the remainder recorded as goodwill, based
on estimates of fair values as follows (dollars in thousands):
Working capital ............................................. $ 7,840
Property and equipment ...................................... 107,047
Goodwill .................................................... 407,441
Favorable acquired business center operating leases ......... 25,690
Other assets ................................................ 32,504
Other liabilities ........................................... (45,080)
Notes payable ............................................... (138,693)
----------
Total .................................................... $ 396,749
==========
The estimates of fair value were determined by HQ's management based on
information provided by the management of the acquired entities. The above
purchase price allocation has been revised from the original allocation as
estimated amounts have been finalized.
HQ is a provider of flexible officing solutions. As of December 31, 2001,
HQ owned, operated, or franchised 385 business centers which are included in
continuing operations and are primarily located in the United States. There were
40 business centers operating at December 31, 2001 that were held for sale and
are included in discontinued operations or in the process of being closed. A
wholly-owned subsidiary of HQ is also the franchiser of 51 domestic and 31
international business centers for unrelated franchisees. HQ provides a complete
outsourced office solution through furnished and equipped individual offices and
multi-office suites available on short notice with flexible contracts. HQ also
provides business support and information services including:
telecommunications; broadband Internet access; mail room and reception services;
high speed copying, faxing and printing services; secretarial, desktop
publishing and IT support services and various size conference facilities, with
multi-media presentation and video teleconferencing capabilities. HQ also
provides similar services for those businesses and individuals that do not
require offices on a full-time basis.
UNAUDITED PRO FORMA INFORMATION
The unaudited pro forma financial information set forth below is based upon
the historical statements of operations of FrontLine for the years ended
December 31, 2000 and 1999, adjusted to give effect to the HQ Merger as of the
beginning of each period presented. The pro forma financial information is
presented for informational purposes only and may not be indicative of what
actual results of operations would have been had the HQ Merger occurred as
presented, nor does it purport to represent the results of operations for future
periods (in millions, except per share amounts).
YEAR ENDED DECEMBER 31,
---------------------------
2000 1999
------------- -------------
Revenues ............................................ $ 612.3 $ 473.3
Net loss ............................................ (222.9) (100.8)
Net loss applicable to common shareholders .......... (225.0) (100.8)
Basic and diluted net loss per common share ......... $ (6.45) $ (2.91)
OWNERSHIP BY FRONTLINE
To facilitate HQ Global obtaining amendments to certain debt covenants, on
June 29, 2001, FrontLine invested an additional $15 million into HQ Global via
the acquisition of a new subordinated series of preferred stock and common stock
warrants.
IV-22
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999, 2000, 2001 - (CONTINUED)
3. INTEREST IN HQ GLOBAL AND PREDECESSOR ENTITIES - (CONTINUED)
As of December 31, 2001, FrontLine's ownership interest was approximately
57% on a basic basis. Although FrontLine's percentage ownership may vary
depending on the actual preferred stock conversion price, on a fully-diluted
basis, assuming the outstanding preferred stock converted at the HQ Merger
conversion price, and including certain warrants to purchase HQ Global stock,
FrontLine would own approximately 38% of the common stock of HQ Global.
An HQ Global shareholder has a put option ("Put Option") to require the
Company to purchase all of its interest any time between January 8, 2002 and
January 8, 2005, at the then determined fair value of the interest.
The Company has entered into a stockholders agreement (the "HQ Stockholders
Agreement") with certain of the stockholders of HQ Global which provides them
with rights to put up to approximately 3.1 million shares of HQ Global (the "HQ
Shares") to the Company during the two years subsequent to the HQ Merger if HQ
Global has not completed an initial public offering of its shares. On February
25, 2002, such stockholders irrevocably waived their Put Rights.
HQ GLOBAL BANKRUPTCY
On March 13, 2002, HQ Global and certain of its affiliates (collectively,
the "Debtors") filed voluntary petitions for relief under Chapter 11 of the
United States Bankruptcy Code in the United States Bankruptcy Court for the
District of Delaware (the "Court"). The Debtors will continue to operate and
manage properties in the ordinary course of business during the Chapter 11
proceeding. The Debtors have the exclusive right to propose a plan of
reorganization during the 120-day period following March 13, 2002, which period
may be extended by the Court.
The Debtors anticipate proposing a plan of reorganization in accordance
with the federal bankruptcy laws as administered by the Court. Confirmation of a
plan of reorganization could materially change the amounts currently recorded in
the financial statements. The financial statements do not give effect to any
adjustment to the carrying value of assets, or amounts and classifications of
liabilities that might be necessary as a consequence of this matter.
Through December 31, 2001, HQ has incurred professional fees of
approximately $5.7 million relating to the restructuring of its business, which
is included in restructuring costs in the accompanying statement of operations
(see Note 14).
DISCONTINUED OPERATIONS
In December 2001, HQ's Board of Directors approved a plan to dispose of
HQ's business in Europe. The planned disposition of the businesses in Europe
represents the disposal of a business segment under Accounting Principles Board
("APB") Opinion No. 30, Reporting the Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions ("APB 30"). As a result of this
transaction, the consolidated financial statements for the years ended December
31, 2001, 2000 and 1999 have been reclassified to present the European
businesses as a discontinued operation.
IV-23
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999, 2000, 2001 - (CONTINUED)
3. INTEREST IN HQ GLOBAL AND PREDECESSOR ENTITIES - (CONTINUED)
Summarized financial information for the discontinued operations is as
follows (in thousands):
YEAR ENDED DECEMBER 31,
-------------------------
2001 2000
-------------- ----------
Revenues ................................................ $ 42,078 $ 28,471
========== ========
Income (loss) before provision for income taxes ......... $ (142,780) $ 3,059
(Provision) for income taxes ............................ (1,838) (1,988)
---------- --------
Income (loss) from discontinued operations, net ......... $ (144,618) $ 1,071
========== ========
The loss from discontinued operations for the year ended December 31, 2001
contains an asset impairment charge of $141.2 million.
The major classes of assets and liabilities of the discontinued operations
included in the consolidated balance sheet were as follows (in thousands):
DECEMBER 31,
-------------------------
2001 2000
------------ ------------
Current assets ................................. $ 14,191 $ 16,792
Property and equipment, net .................... 8,546 19,672
Investments .................................... 9,387 30,531
Intangibles and noncurrent assets, net ......... -- 86,198
Liabilities .................................... (26,624) (12,848)
--------- ---------
Net assets ..................................... $ 5,500 $ 140,345
========= =========
FINANCIAL STATEMENTS
The following statements present the portion of the Company's financial
position, results of operations and cash flows represented by HQ Global and
predecessor entities as of and for the periods indicated.
IV-24
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999, 2000, 2001 - (CONTINUED)
3. INTEREST IN HQ GLOBAL AND PREDECESSOR ENTITIES - (CONTINUED)
HQ GLOBAL AND PREDECESSOR ENTITIES BALANCE SHEETS (IN THOUSANDS)
DECEMBER 31,
---------------------------
2001 2000
------------- -------------
ASSETS:
Current Assets:
Cash and cash equivalents ......................................................... $ 16,151 $ 12,742
Restricted cash ................................................................... 878 5,768
Accounts receivable, net of allowance for doubtful accounts of $2,492 and $3,393
at December 31, 2001 and 2000, respectively ..................................... 6,865 31,988
Other current assets .............................................................. 4,141 7,470
---------- ----------
Total Current Assets ........................................................... 28,035 57,968
Intangible assets, net ............................................................. 16,820 581,680
Property and equipment, net ........................................................ 168,486 202,005
Deferred financing costs, net ...................................................... 40,127 48,246
Net assets from discontinued operations ............................................ 5,500 140,345
Other assets, net .................................................................. 4,130 10,347
---------- ----------
Total Assets ................................................................... $ 263,098 $1,040,591
========== ==========
LIABILITIES AND NET BUSINESS UNIT (DEFICIENCY) EQUITY:
Current Liabilities:
Accounts payable and accrued expenses ............................................. $ 57,184 $ 51,136
Accrued restructuring costs ....................................................... 51,567 --
Subordinated notes payable ........................................................ 341,506 --
Current portion of senior secured debt ............................................ -- 32,999
Deferred rent payable ............................................................. 3,345 2,713
Other current liabilities ......................................................... 988 2,558
---------- ----------
Total Current Liabilities ...................................................... 454,590 89,406
Senior secured debt ................................................................ -- 179,926
Subordinated notes payable ......................................................... -- 125,000
Deferred rent payable .............................................................. 49,102 38,562
Other liabilities .................................................................. 50,496 62,530
---------- ----------
Total Liabilities .............................................................. 554,188 495,424
Minority interest .................................................................. -- 305,577
Net business unit (deficiency) equity .............................................. (291,090) 239,590
---------- ----------
Total Liabilities and Net Business Unit (Deficiency) Equity .................... $ 263,098 $1,040,591
========== ==========
IV-25
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999, 2000, 2001 - (CONTINUED)
3. INTEREST IN HQ GLOBAL AND PREDECESSOR ENTITIES - (CONTINUED)
HQ GLOBAL AND PREDECESSOR ENTITIES STATEMENTS OF OPERATIONS (IN THOUSANDS,
EXCEPT SHARE AMOUNTS)
YEAR ENDED DECEMBER 31,
------------------------------------------
2001 2000 1999
------------- ------------- --------------
HQ Operating Revenues:
Workstation revenue ............................................. $ 310,520 $ 279,561 $ 129,026
Support services ................................................ 160,187 175,929 85,419
----------- ----------- -----------
Total HQ Operating Revenues ................................... 470,707 455,490 214,445
----------- ----------- -----------
HQ Operating Expenses:
Rent ............................................................ 219,826 170,334 87,775
Support services ................................................ 58,055 53,610 26,345
Center general and administrative ............................... 107,641 93,263 54,839
General and administrative ...................................... 60,831 50,436 17,959
----------- ----------- -----------
Total HQ Operating Expenses ................................... 446,353 367,643 186,918
----------- ----------- -----------
HQ Operating Income ........................................... 24,354 87,847 27,527
HQ Other Expenses:
Impairment of assets ............................................ (561,196) -- --
Depreciation and amortization ................................... (70,102) (51,368) (15,004)
Restructuring costs ............................................. (57,553) -- --
Interest expense, net ........................................... (44,387) (32,303) (10,199)
Merger and integration costs .................................... -- (24,701) (26,730)
----------- ----------- -----------
Loss from continuing operations before income taxes and
minority interest ............................................ (708,884) (20,525) (24,406)
(Provision for) benefit from income taxes ........................ (792) (3,439) 2,841
Minority interest ................................................ 305,984 (7,688) 18,790
----------- ----------- -----------
Loss before discontinued operations .............................. (403,692) (31,652) (2,775)
Income (loss) from discontinued operations ....................... (144,618) 1,071 --
----------- ----------- -----------
Net loss attributable to HQ ................................... $ (548,310) $ (30,581) $ (2,775)
=========== =========== ===========
Basic and diluted net loss attributable to HQ per weighted average
common share .................................................... $ (14.82) $ (0.88) $ (0.11)
=========== =========== ===========
Basic and diluted weighted average common shares of FrontLine
outstanding ..................................................... 37,009,891 34,880,709 25,600,985
=========== =========== ===========
IV-26
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999, 2000, 2001 - (CONTINUED)
3. INTEREST IN HQ GLOBAL AND PREDECESSOR ENTITIES - (CONTINUED)
HQ GLOBAL AND PREDECESSOR STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED DECEMBER 31,
-----------------------------------------
2001 2000 1999
-------------- ------------- ------------
Cash Flows from Operating Activities:
Loss before discontinued operations attributable to HQ ......................... $ (403,692) $ (31,652) $ (2,775)
Adjustments to reconcile loss before discontinued operations attributable to
HQ to cash provided by operating activities:
Depreciation and amortization ............................................... 70,102 51,368 15,004
Impairment of assets ........................................................ 561,196 -- --
Amortization of deferred financing costs .................................... 8,125 4,920 719
Minority interest ........................................................... (305,984) 7,688 (18,790)
Stock and related compensation .............................................. (738) 858 12,493
Non-cash restructuring costs ................................................ 57,661
Deferred income taxes ....................................................... -- -- (3,541)
Cumulative translation adjustment ........................................... -- -- --
Changes in operating assets and liabilities:
Accounts receivable, net ................................................... 25,123 (19,801) (1,328)
Acquisition costs and other assets ......................................... 5,787 18,975 (5,473)
Deferred rent payable ...................................................... 9,896 16,455 6,024
Accounts payable and accrued expenses ...................................... 6,041 (34,076) 19,755
Accrued restructuring costs ................................................ (6,094) -- --
Other liabilities .......................................................... (12,166) 8,206 2,527
---------- ---------- ---------
Net cash provided by operating activities from continuing
Operations .............................................................. 15,257 22,941 24,615
Net cash provided by discontinued operations ............................. 14,423 1,397 --
---------- ---------- ---------
Net cash provided by operating activities ................................ 29,680 24,338 24,615
---------- ---------- ---------
Cash Flows from Investing Activities:
Acquisitions of officing solutions centers, net of cash proceeds ............... -- (251,051) (47,329)
Equipment ...................................................................... (35,381) (57,722) (41,541)
Restricted cash ................................................................ 4,890 22,866 (10,318)
---------- ---------- ---------
Net cash used in continuing investing activities ......................... (30,491) (285,907) (99,188)
Net cash used in discontinued operations ................................. (12,011) (2,746) --
---------- ---------- ---------
Net cash used in investing activities .................................... (42,502) (288,653) (99,188)
---------- ---------- ---------
Cash Flows from Financing Activities:
Net proceeds from Parent ....................................................... 15,000 18,424 23,817
Deferred financing costs ....................................................... -- (25,732) --
Net proceeds from notes payable ................................................ 3,581 75,022 44,532
Capital leases ................................................................. (1,984) (2,657) (2,226)
Net proceeds from minority interest ............................................ (366) 208,193 8,642
---------- ---------- ---------
Net cash provided by financing activities ................................ 16,231 273,250 74,765
---------- ---------- ---------
Cash and Cash Equivalents:
Net increase ................................................................... 3,409 8,935 192
Beginning of period ............................................................ 12,742 3,807 3,615
---------- ---------- ---------
End of period .................................................................. $ 16,151 $ 12,742 $ 3,807
========== ========== =========
IV-27
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 1999, 2000 AND 2001 - (CONTINUED)
4. OTHER OWNERSHIP INTERESTS
The Company's ownership interests in its investees are classified according
to the applicable accounting method utilized at December 31, 2001 and 2000. The
carrying value of equity method investments represents the Company's acquisition
cost less any impairment charges and the Company's share of such investees'
losses. The carrying value of cost method investments represents the Company's
acquisition costs less any impairment charges in such investees. The Company's
ownership interests in and advances to investees as of December 31, 2001, are as
follows (in thousands):
DECEMBER 31, 2001 DECEMBER 31, 2000
------------------------------ ------------------------------
CARRYING VALUE COST CARRYING VALUE COST
---------------- ----------- ---------------- -----------
Equity Method ......... $13,396 $158,671 $32,969 $156,104
Cost Method ........... -- 18,075 6,876 17,700
------- -------
$13,396 $39,845
======= =======
The following details the Company's equity in net loss and impairment of
unconsolidated companies (in thousands):
YEAR ENDED DECEMBER 31,
--------------------------------------------
2001 2000 1999
------------- ------------- ------------
OnSite Access, Inc. and predecessor entity ............................. $ -- $ (39,017) $ (8,137)
RealtyIQ Corp. ......................................................... -- (38,797) (11)
EmployeeMatters, Inc. .................................................. -- (15,139) (2,230)
Gain on sale of EmployeeMatters, Inc. (see below) ...................... -- 8,287 --
Reckson Strategic Venture Partners ..................................... (5,069) (4,421) 638
Other unconsolidated companies ......................................... -- (11,101) (526)
Aggregate impairment charges (see Note 14) ............................. (31,970) (25,740) --
Gain on Sale of Intuit, Inc. stock ..................................... 591 -- --
-------- --------- --------
Equity in net loss and impairment of unconsolidated companies ......... $(36,448) $(125,928) $(10,266)
======== ========= ========
EMPLOYEEMATTERS
On December 20, 2000, the Company sold its interest in EmployeeMatters,
Inc. ("EmployeeMatters") to Intuit, Inc. ("Intuit") for 556,027 shares of Intuit
common stock. The fair value of such stock on the closing date of the sale was
$21.3 million. As a result of the sale, the Company recorded a gain of $8.3
million, net of $0.7 million of expenses and other related charges, in the
fourth quarter of the year ended December 31, 2000. Included in the above Intuit
shares are 23,072 shares that were held in escrow in order to collateralize
certain contingent indemnification obligations of the Company. On December 31,
2001, Intuit shares were released from escrow.
SALE OF INTUIT
During the three months ended March 31, 2001, the Company sold all shares
of Intuit not held in escrow at a realized gain of $0.5 million. On January 9,
2002, the Company sold all 23,072 shares of Intuit, which were released from
escrow at December 31, 2001. As a result of this sale, the Company recorded a
gain of $0.1 million.
RECKSON STRATEGIC
Reckson Strategic invests in operating companies with experienced
management teams in real estate and real estate related market sectors which are
in the early stages of their growth cycle or offer unique circumstances for
attractive investments, as well as platforms for future growth.
IV-28
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 1999, 2000 AND 2001 - (CONTINUED)
4. OTHER OWNERSHIP INTERESTS - (CONTINUED)
Through RSVP Holdings, LLC ("Holdings"), the Company is a managing member
and 100% owner of the common equity of Reckson Strategic. New World Realty, LLC,
an entity owned by two individuals (the "RSVP Managing Directors") retained by
Holdings, acts as a managing member of Holdings, and have a carried interest
which provides for the RSVP Managing Directors to receive a share in the profits
of Reckson Strategic after the Company, Paine Webber Real Estate Securities,
Inc., ("Paine Webber") and Stratum Realty Fund, L.P. ("Stratum") have received
certain minimum returns and a return of capital. Paine Webber and Stratum are
non-managing members and preferred equity owners who have committed $150 million
and $50 million, respectively, in capital and share in profits and losses of
Reckson Strategic with the Company, subject to a maximum internal rate of return
of 16% of invested capital. The carrying values of the Company's investment in
Reckson Strategic were $13.4 million and $29.0 million as of December 31, 2001
and 2000, respectively.
During the three months ended September 30, 2001, the Company recognized a
$20.0 million valuation impairment based on its assessment of value,
recoverability and probability that this investment would not ultimately be
realized at its otherwise carrying value.
FINANCIAL STATEMENTS
The following statements present the portion of the Company's financial
position, results of operations and cash flows represented by FrontLine Parent
and other interests as of and for the periods indicated.
IV-29
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 1999, 2000 AND 2001 - (CONTINUED)
4. OTHER OWNERSHIP INTERESTS - (CONTINUED)
FRONTLINE PARENT AND OTHER INTERESTS BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE
AMOUNTS)
DECEMBER 31,
---------------------------
2001 2000
------------- -------------
ASSETS:
Current Assets:
Cash and cash equivalents .......................................................... $ 1,988 $ 6,923
Other current assets ............................................................... 361 21,928
---------- ----------
Total Current Assets ............................................................. 2,349 28,851
Ownership interests in and advances to unconsolidated companies ..................... 13,396 39,845
Ownership interests in HQ Global and predecessor entities ........................... -- 239,590
Deferred financing costs ............................................................ 147 629
Other assets, net ................................................................... 1,778 9,536
---------- ----------
Total Assets .................................................................... $ 17,670 $ 318,451
========== ==========
LIABILITIES AND SHAREHOLDERS' (DEFICIENCY) EQUITY:
Current Liabilities:
Accounts payable and accrued expenses .............................................. $ 4,036 $ 9,246
Credit facilities with related parties ............................................. 176,909 --
Notes payable ...................................................................... 25,000 25,000
Negative ownership interest in HQ Global and predecessor entities .................. 291,090 --
---------- ----------
Total Current Liabilities ........................................................ 497,035 34,246
Credit facilities with related parties .............................................. -- 135,523
Other liabilities ................................................................... -- 13,899
---------- ----------
Total Liabilities ................................................................ 497,035 183,668
---------- ----------
Redeemable convertible preferred stock .............................................. 25,325 13,940
Shareholders' (Deficiency) Equity:
8.875% convertible cumulative preferred stock, $.01 par value, 25,000,000 shares
authorized, 26,000 outstanding, at December 31, 2001 and 2000 .................... -- --
Common stock, $.01 par value, 100,000,000 shares authorized, 37,344,039 and
36,625,847 shares issued and outstanding at December 31, 2001 and 2000,
respectively ..................................................................... 373 366
Additional paid-in capital ......................................................... 400,793 400,916
Accumulated deficit ................................................................ (905,856) (281,030)
Unrealized gain on marketable equity securities .................................... -- 591
---------- ----------
Total Shareholders' (Deficiency) Equity .......................................... (504,690) 120,843
---------- ----------
Total Liabilities and Shareholders' (Deficiency) Equity .......................... $ 17,670 $ 318,451
========== ==========
IV-30
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 1999, 2000 AND 2001 - (CONTINUED)
4. OTHER OWNERSHIP INTERESTS - (CONTINUED)
FRONTLINE PARENT AND OTHER INTERESTS STATEMENTS OF OPERATIONS (IN THOUSANDS,
EXCEPT SHARE AMOUNTS)
YEAR ENDED DECEMBER 31,
-------------------------------------------
2001 2000 1999
-------------- ------------- --------------
Parent Expenses:
General and administrative expenses .................................. $ (3,915) $ (16,478) $ (9,509)
Amortization of deferred charges ..................................... (2,274) (14,330) (8,455)
Restructuring costs .................................................. (11,490) (12,788) --
Interest expense, net ................................................ (22,389) (18,903) (8,166)
Depreciation and amortization ........................................ -- (1,123) (676)
Development stage company costs ...................................... -- (9,999) --
----------- ---------- -----------
Loss before equity in net loss and impairment of
unconsolidated companies .......................................... (40,068) (73,621) (26,806)
Equity in net loss and impairment of unconsolidated companies ......... (36,448) (125,928) (10,266)
----------- ---------- -----------
Loss before extraordinary item from early extinguishment of
debt .............................................................. (76,516) (199,549) (37,072)
Extraordinary item from early extinguishment of debt .................. -- (2,648) --
----------- ---------- -----------
Net loss ........................................................... (76,516) (202,197) (37,072)
Dividends on and accretion of preferred stock ......................... (5,582) (2,119) --
----------- ---------- -----------
Net loss applicable to common shareholders attributable to
Parent and Other Interests ........................................ $ (82,098) $ (204,316) $ (37,072)
=========== ========== ===========
Basic and diluted net loss attributable to Parent and Other Interests
per weighted average common share .................................... $ (2.22) $ (5.86) $ (1.45)
=========== ========== ===========
Basic and diluted weighted average common shares of FrontLine
outstanding .......................................................... 37,009,891 34,880,709 25,600,985
=========== ========== ===========
IV-31
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 1999, 2000 AND 2001 - (CONTINUED)
4. OTHER OWNERSHIP INTERESTS - (CONTINUED)
FRONTLINE PARENT AND OTHER INTERESTS STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED DECEMBER 31,
----------------------------------------------
2001 2000 1999
------------- -------------- -------------
Cash Flows from Operating Activities:
Net loss ..................................................... $ (76,516) $ (202,197) $ (37,072)
Adjustments to reconcile net loss to cash used in operating
activities:
Depreciation and amortization ............................. -- 1,123 676
Amortization of deferred financing costs .................. 783 800 --
Extraordinary loss on early extinguishment of debt ........ -- 2,648 --
Equity in net loss of unconsolidated companies ............ 36,448 125,928 10,266
Stock and related compensation ............................ 2,814 14,330 18,000
Non-cash restructuring costs .............................. 2,134 8,875 --
Changes in operating assets and liabilities:
Acquisition costs and other assets ...................... 5,413 (1,735) (1,778)
Accounts payable and accrued expenses ................... (9,415) (6,678) 79
Affiliate receivables ................................... -- -- 7,759
Other liabilities ....................................... 20,948 8,369 (2,439)
--------- ---------- ----------
Net cash used in operating activities .................. (17,391) (48,537) (4,509)
--------- ---------- ----------
Cash Flows from Investing Activities:
Acquisitions of officing solutions centers ................... (15,000) (91,026) --
Proceeds from sale of short-term investments ................. 20,918 -- --
Equipment .................................................... -- (3,019) (341)
Acquisition of ownership interests and advances to
unconsolidated companies ................................... (10,426) (68,322) (132,332)
--------- ---------- ----------
Net cash used in investing activities .................. (4,508) (162,367) (132,673)
--------- ---------- ----------
Cash Flows from Financing Activities:
Issuance of common stock and warrants, net of costs .......... -- 156,957 36,995
Issuance of preferred and redeemable preferred stock, net of
costs ...................................................... 10,000 38,510 --
Deferred financing costs ..................................... -- (1,429) (4,398)
Net proceeds from credit facilities with related parties ..... 6,538 13,675 128,492
Net proceeds from notes payable .............................. -- (19,407) (125)
Other, net ................................................... 426 588 3,125
--------- ---------- ----------
Net cash provided by financing activities .............. 16,964 188,894 164,089
--------- ---------- ----------
Cash and Cash Equivalents:
Net (decrease) increase ...................................... (4,935) (22,010) 26,907
Beginning of period .......................................... 6,923 28,933 2,026
--------- ---------- ----------
End of period ................................................ $ 1,988 $ 6,923 $ 28,933
========= ========== ==========
IV-32
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 1999, 2000 AND 2001 - (CONTINUED)
5. PROPERTY AND EQUIPMENT
Property and equipment consists of (in thousands):
YEAR ENDED DECEMBER 31,
-------------------------
2001 2000
------------ ------------
Office equipment, furniture and fixtures .................... $ 156,940 $ 178,228
Enterprise resource system .................................. 12,438 10,201
Leasehold improvements ...................................... 76,711 55,840
--------- ---------
246,089 244,269
Less accumulated depreciation and amortization .............. (77,603) (42,264)
--------- ---------
$ 168,486 $ 202,005
========= =========
Office equipment, furniture and fixtures include approximately $6.7 million
and $6.8 million of office equipment under capital leases, net of accumulated
depreciation of $3.6 million and $2.0 million as of December 31, 2001 and 2000,
respectively.
6. INTANGIBLE ASSETS
Intangible assets consist of (in thousands):
YEAR ENDED DECEMBER 31,
-------------------------
2001 2000
----------- -------------
Goodwill .................................................... $ -- $ 588,350
Favorable acquired business center operating leases ......... 19,984 25,690
Other intangible assets ..................................... -- 854
Less accumulated amortization ............................... (3,164) (33,214)
-------- ---------
$ 16,820 $ 581,680
======== =========
See Note 2 for more detail.
7. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses consist of (in thousands):
YEAR ENDED DECEMBER 31,
-------------------------
2001 2000
----------- -------------
Accounts payable ............................................ $ 24,858 $ 27,337
Accrued compensation and benefits ........................... 7,444 7,729
Client prepayments .......................................... 5,698 5,028
Accrued merger and integration costs ........................ -- 1,992
Other ....................................................... 23,220 18,296
-------- --------
$ 61,220 $ 60,382
======== ========
IV-33
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 1999, 2000 AND 2001 - (CONTINUED)
8. INCOME TAXES
The Company uses the asset and liability method of accounting for income taxes.
Under the asset and liability method, deferred tax assets and liabilities are
recognized for the estimated future tax consequences attributable to
differences between financial statement carrying amounts of existing assets and
liabilities and their respective tax bases. This method also requires the
recognition of future tax benefits such as net operating loss carry forwards, to
the extent that realization of such benefits is more likely than not. Deferred
tax assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax assets and
liabilites of a change in tax rates is recognized in the period that includes
the enactment date. The result a valuation allowance is recognized if it is more
likely than not that some portion of the deferred asset will not be recognized.
At December 31, 2001, all of FrontLine Parent's deferred tax assets have been
fully reserved due to the uncertainty as to whether these assets will provide
benefit in future years.
The following represents HQ's, the Company's principal subisdiary (i) provision
(benefit) for income taxes (ii) reconciliation of income tax expense (benefit)
computed using the U.S. federal statutory income tax rate to the provision
(benefit) for income taxes and (iii) the deferred tax effects of temporary
difference as of December 31, 2001 and 2000.
HQ's provision (benefit) for income taxes related to continuing operations
consists of the following (in thousands):
YEAR ENDED DECEMBER 31,
----------------------------------------------
2001 2000 1999
-------------- ------------- -------------
Current:
Foreign ................................................................ $ 228 $ 396 $ 100
State and local ........................................................ 564 3,043 600
---------- --------- ---------
792 3,439 700
Deferred:
Federal ................................................................ -- -- (3,291)
State and local ........................................................ -- -- (250)
---------- --------- ---------
-- -- (3,541)
---------- --------- ---------
Total (benefit) provision ............................................... $ 792 $ 3,439 $ (2,841)
========== ========= =========
The following is HQ's reconciliation of the income tax expense (benefit)
computed using the U.S. federal statutory income tax rate to the provision
(benefit) for income taxes (in thousands):
YEAR ENDED DECEMBER 31,
----------------------------------------------
2001 2000 1999
-------------- ------------- -------------
Income tax expense (benefit) at federal statutory rate .................. $ (216,083) $ (6,077) $ (8,248)
Nondeductible goodwill .................................................. 83,401 4,170 928
State and local income taxes, net of federal income tax benefit ......... 564 3,043 (36)
Effect of foreign income taxes .......................................... 7 (124) --
Benefit of net operating losses not recognized .......................... 132,749 2,220 4,515
Other, net .............................................................. 154 207 --
---------- --------- ---------
Total provision (benefit) ............................................... $ 792 $ 3,439 $ (2,841)
========== ========= =========
HQ's deferred tax effects of temporary differences as of December 31, 2001
and 2000 are as follows (in thousands):
YEAR ENDED DECEMBER 31,
------------------------------
2001 2000
------------- -------------
Deferred tax assets:
Net operating losses ................................................... $ 59,584 $ 24,637
Accounts receivable allowance .......................................... 942 1,293
AMT credit carryforward ................................................ 252 252
Deferred rent payable .................................................. 9,616 7,206
Deferred restructuring charges ......................................... 18,488 --
Intangible assets ...................................................... 72,345 --
Other .................................................................. 1,967 3,951
---------- ---------
163,194 37,339
Less valuation allowance ................................................ (150,861) (10,385)
---------- ---------
12,333 26,954
Deferred tax liabilities:
Fixed assets ........................................................... (11,741) (10,209)
Intangibles ............................................................ -- (9,206)
Other .................................................................. (592) (7,539)
---------- ---------
(12,333) (26,954)
---------- ---------
Net deferred tax asset after valuation allowance ........................ $ -- $ --
========== =========
IV-34
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 1999, 2000 AND 2001 - (CONTINUED)
8. INCOME TAXES - (CONTINUED)
At December 31, 2001 and 2000, HQ had established valuation allowances of
$150.9 million and $10.4 million, respectively, to reduce certain deferred tax
assets to amounts that are more likely than not to be realized.
At December 31, 2001, Frontline has approximately $274.2 million of
available unused net operating loss carryforwards, which expire beginning in
2017. At December 31, 2001 HQ has available unused net operating loss
carryforwards for U.S. federal income tax purposes of approximately $171.5
million, which expire beginning in 2003. A change in ownership, as defined for
purposes of the Internal Revenue Code, occurred in 2000 and will limit the
annual utilization of a portion of the U.S. Federal net operating loss
carryforward under the applicable Internal Revenue Service regulations.
9. NOTES PAYABLE
HQ DEBTOR-IN-POSSESSION FACILITY
In connection with HQ's bankruptcy filing (See Note 1), HQ received a
commitment for a $30.0 million facility, with borrowings permitted for up to
nine months in accordance with certain operating and liquidity covenants. Any
borrowings, of which there have been none, will incur interest at prime plus 3%.
HQ CREDIT FACILITY
HQ has a credit facility (the "HQ Credit Facility") with certain lending
institutions, which, as amended and restated as of June 29, 2001, provides for
borrowings of up to $219.4 million under four term loans (the "Term Loans") and
for borrowings or letters of credit of up to an additional $55.6 million under
two revolving loan commitments (the "Revolver Loans"). Availabilities under the
Revolver Loans are formula based. As of December 31, 2001, there was $188.7
million in outstanding borrowings under the Term Loans and $27.8 million in
borrowings outstanding under the Revolver Loans. As of December 31, 2001, HQ had
letters of credit outstanding in the aggregate amount of $28.4 million for
landlord security deposits. Such letters of credit are collateralized by $0.8
million in cash and $27.6 million of Revolver Loans, leaving $0.2 million
available under the Revolver Loans for additional borrowings.
The Term Loans are repayable in various quarterly installments through
November 2005. Additional annual principal payments of 75% of excess cash flow
as defined are required. Pursuant to such requirement, HQ made an accelerated
principal payment of $15.1 million during the twelve-month period ended December
31, 2001, based on cash flows for the year ended December 31, 2000. Any
outstanding borrowings under the two Revolver Loans are due on November 6, 2003
and May 31, 2005, respectively. Borrowings under the HQ Credit Facility bear
interest ranging from LIBOR (one-month LIBOR was approximately 1.88% at December
31, 2001) plus 3.25% to 4.0% for one, three or nine-month periods at the
election of HQ or prime (4.75% at December 31, 2001) plus 2.25% to 3.00%. The
weighted average interest rate on borrowings under the Term Loans and the
Revolver Loans at December 31, 2001, were approximately 5.9% and 6.0%,
respectively. HQ pays a commitment fee of 1/2 of 1.0% per annum on the unused
portion of the HQ Credit Facility.
HQ's lending institutions have an assignment of leases and rents associated
with HQ's business centers and certain preferred security interests to
collateralize the borrowings under the HQ Credit Facility.
During 2000, interest on borrowings under the Credit Facility ranged from
LIBOR (one month LIBOR was approximately 6.8% at December 31, 2000) plus 3.00%
to 3.5% for a one, three or six month period, at the election of the Company or
Prime (9.5% at December 31, 2000). During 1999, interest on borrowings under the
Credit Facility ranged from LIBOR plus 3.00% (9.5% at December 31, 1999) to
LIBOR plus 3.75% (10.25% at December 31, 1999) for a one, three or six month
period, at the election of HQ.
IV-35
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 1999, 2000 AND 2001 - (CONTINUED)
9. NOTES PAYABLE - (CONTINUED)
The stated maturities of borrowings outstanding under the HQ Credit
Facility subsequent to December 31, 2001 are as follows (in thousands):
AMOUNT
-----------
2002 and arrears ................... $ 31,315
2003 ............................... 29,665
2004 ............................... 58,976
2005 ............................... 96,587
--------
Total .............................. $216,543
========
MEZZANINE LOAN
On May 31, 2000, HQ entered into a Senior Subordinated Credit Facility (the
"Bridge Loan") in the amount of $125.0 million. The Bridge Loan carried an
interest rate of LIBOR plus 6.5% and was to mature on May 31, 2007. On August
11, 2000, HQ replaced the Bridge Loan with a $125.0 million Note and Warrant
Purchase Agreement (the "Mezzanine Loan"). The Mezzanine Loan bears interest at
13.5% per annum and matures on May 31, 2007. The entire balance was outstanding
at December 31, 2001 and 2000.
In connection with the Mezzanine Loan, the Mezzanine Loan lenders received
503,545 Series A Warrants and 227,163 Series B Warrants to purchase common
stock. The fair value of the Series A Warrants to purchase Common Stock issued
to the lenders was recorded as debt issuance costs and is being amortized over
the terms of the related loan resulting in an effective interest rate of 15.6%.
No value will be assigned to the Series B Warrants.
EVENTS OF DEFAULT AND COMPLIANCE WITH COVENANTS
The HQ Credit Facility and Mezzanine Loan contain certain covenants,
including a defined maximum ratio of consolidated indebtedness to consolidated
earnings before interest, income taxes, depreciation and amortization. In
addition, there are other covenants pertaining to financial ratios and
limitations on capital expenditures. Also, the HQ Credit Facility and Mezzanine
Loan prohibit the declaration or payment of dividends by HQ Global or any of its
subsidiaries, except for the payment of dividends in kind on its preferred
stock.
In addition to not complying with certain financial covenants, in September
2001, HQ defaulted on its principle payments due under the HQ Credit Facility
and, in February 2002, commenced defaulting on interest payments. As a result of
entering into forbearance agreements, additional borrowings under the HQ Credit
Facility were permitted from September 30, 2001 to February 14, 2002. Due to
these defaults, outstanding borrowings are reflected as a current liability as
of December 31, 2001.
HQ also defaulted on the September 30, 2001 interest payment on the
Mezzanine Loan but did enter into a forbearance agreement that expired February
14, 2002. As a result of this default and non-compliance with financial
covenants, the Mezzanine Loan has been classified as a current liability as of
December 31, 2001.
FRONTLINE BANK CREDIT FACILITY
On September 11, 2000, FrontLine entered into a $25.0 million line of
credit agreement (the "FrontLine Bank Credit Facility"). Borrowings under the
FrontLine Bank Credit Facility are secured by a 20.51% common ownership interest
in shares of HQ Global and bear interest at the Prime rate plus 2%.
IV-36
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 1999, 2000 AND 2001 - (CONTINUED)
9. NOTES PAYABLE - (CONTINUED)
Any outstanding borrowings under the FrontLine Bank Credit Facility were
originally due on March 11, 2001. In January 2001, FrontLine exercised its
option to extend the maturity date until June 11, 2001. In May 2001, the Company
further extended the maturity date to September 11, 2001. In September 2001, the
Company further extended the maturity date to October 25, 2001. At December 31,
2001, FrontLine has borrowed $25.0 million under the amended FrontLine Bank
Credit Facility. Such amount is classified as current in the accompanying
Consolidated Balance Sheet. The weighted average interest rate of the
outstanding borrowings at such date was 7.66%. The carrying value of FrontLine's
borrowings under the FrontLine Bank Credit Facility approximates its fair value
as of December 31, 2001. Subsequent to December 31, 2001, the Company has not
repaid the principal or paid any interest applicable to this period and is
accordingly in default. The Company is currently in negotiations to further
extend the maturity or restructure the terms of this facility. However, no
assurances can be given that any further extensions or restructuring of the
terms of this credit facility will be agreed upon.
The restructuring of the Company's indebtedness may result in significant
dilution to holders of the Company's common stock or the elimination of their
interest.
10. REDEEMABLE PREFERRED STOCK
On December 13, 2000, FrontLine obtained a $25.0 million preferred equity
facility (the "Preferred Equity Facility") with a major financial institution.
At the inception of the Preferred Equity Facility, the Company drew $15.0
million, for net proceeds of $13.9 million; the remaining amount was drawn by
FrontLine during the three months ended March 31, 2001, for net proceeds of
$10.0 million.
The Preferred Equity Facility is comprised of a series of redeemable
convertible preferred securities (the "Series B Preferred Stock"). The holders
have consent rights for certain significant transactions, including the
incurrence of additional debt by the Company or HQ, the issuance of equity
securities senior to, or on a parity with, the Series B Preferred Stock or the
issuance by HQ of preferred stock. These securities also contain certain
covenants relating to HQ. In addition, the securities include a redemption
premium of 27.5%. Since the securities were not redeemed prior to December 13,
2001, the securities (including the amount of the redemption premium) have
become convertible at the holder's option into FrontLine common stock at the
initial rate of $13.3875 per share, the preferred stock has become a voting
security on an "as-converted" basis, and quarterly dividends have become payable
from the date of initial issuance at the annual rate of 9.25%. Securities have a
mandatory redemption requirement at a 27.5% premium, which has been triggered as
a result of uncured events of default. Accordingly, the securities are
classified as "Redeemable convertible preferred stock" in the accompanying
consolidated balance sheet at December 31, 2001.
The initial net proceeds of the securities are being accreted to the
mandatory redemption price of 127.5% of face value over the five-year period
through the mandatory redemption date.
At December 31, 2001, the Company did not pay the dividend that was payable
at that time and accordingly is in default. The Company is in arrears with
regard to the payment of dividends on its Series A and Series B Preferred Stock.
11. SHAREHOLDERS' EQUITY
The Company has established the 1998 stock option plan, the 1998 employee
stock option plan, the 1999 stock option plan and the 2000 employee stock option
plan (the "Plans") for the purpose of attracting and retaining directors,
executive officers, other key employees and advisory board members. As of
December 31, 2001, 3,700,376, 100,000, 1,750,000 and 2,500,000 of the Company's
authorized shares have been reserved for issuance under the 1998 stock option
plan, the 1998 employee stock option plan, the 1999 stock option plan and the
2000 employee stock option plan, respectively.
IV-37
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 1999, 2000 AND 2001 - (CONTINUED)
11. SHAREHOLDERS' EQUITY - (CONTINUED)
The following table sets forth the outstanding options by plan and their
corresponding exercise price ranges:
EXERCISE PRICE RANGE
-----------------------
OUTSTANDING
OPTIONS FROM TO
------------ ---------- ----------
1998 Stock Option Plan .................. 757,818 $ 1.04 $ 2.00
1998 Employee Stock Option Plan ......... 1,000 $ 2.00 $ 2.00
1999 Stock Option Plan .................. 122,500 $ 4.63 $ 29.25
2000 Employee Stock Option Plan ......... 409,000 $ 10.63 $ 58.00
---------
Total ................................... 1,290,318
=========
A summary of the Company's stock option activity and related information is
as follows:
WEIGHTED
AVERAGE
OPTION
OPTIONS OPTION PRICE PRICE
-------------------- ------------------ ---------
Granted during the year ended
December 31, 1998 ....................... 3,831,541 (a) $1.04 -- $ 2.00 $ 1.19
---------
Outstanding - December 31, 1998 ......... 3,831,541 $1.04 -- $ 2.00 $ 1.19
Granted .................................. 1,218,500 (a) $4.63 -- $29.25 $ 15.10
Exercised ................................ (210,000) $1.04 -- $ 2.00 $ 1.31
---------
Outstanding - December 31, 1999 ......... 4,840,041 $1.04 -- $29.25 $ 4.69
Granted .................................. 2,159,792 (a) $10.63 -- $58.00 $ 21.88
Exercised ................................ (260,333) $1.04 -- $13.31 $ 4.48
Forfeited ................................ (839,169) $4.63 -- $29.25 $ 17.32
---------
Outstanding - December 31, 2000 ......... 5,900,331 $1.04 -- $58.00 $ 9.19
Exercised ................................ (139,000) $5.52 -- $ 8.42 $ 4.48
Forfeited ................................ (4,471,013) $4.63 -- $29.25 $ 17.32
----------
Outstanding - December 31, 2001 ......... 1,290,318 $1.04 -- $58.00 $ 9.19
----------
- ----------
(a) The weighted average grant date fair value per option (see discussion of
valuation below) was $1.15, $13.23 and $13.15 for the years ended December
31, 1998, 1999 and 2000 respectively.
IV-38
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 1999, 2000 AND 2001 - (CONTINUED)
11. SHAREHOLDERS' EQUITY - (CONTINUED)
The following table sets forth information relating to stock options
outstanding and exercisable at December 31, 2001:
STOCK OPTIONS OUTSTANDING STOCK OPTIONS EXERCISABLE
---------------------------------------------- -------------------------------
WEIGHTED WEIGHTED WEIGHTED
OUTSTANDING AVERAGE AVERAGE OUTSTANDING AVERAGE
AS OF YEARS OPTION AS OF OPTION
OPTION PRICE DECEMBER 31, 2001 REMAINING PRICE DECEMBER 31, 2001 PRICE
- -------------------- ------------------- ----------- ---------- ------------------- ---------
$1.04 629,477 6.25 $ 1.04 629,477 $ 1.04
$1.10 -- $4.63 130,341 6.01 $ 1.13 130,341 $ 1.13
$10.63 -- $21.19 119,500 8.89 $ 16.46 119,167 $ 16.46
$24.88 271,000 8.35 $ 24.88 103,666 $ 24.88
$26.72 -- $29.25 120,000 7.90 $ 28.35 40,002 $ 28.35
$58.00 20,000 8.05 $ 58.00 6,667 $ 58.00
--------- ---------
1,290,318 7.09 $ 10.91 1,029,320 $ 6.67
========= =========
Options granted to officers under the 1998 stock option plan were fully
vested on January 1, 1999. Options granted to new employees generally vest in
three equal installments on the first, second and third anniversaries of the
date of the grant. Options granted under the Plans are generally exercisable at
the market price on the date of the grant and, subject to termination of
employment, expire ten years from date of the grant, are not transferable other
than on death.
In December 1999, the Company formed an advisory board to provide strategic
guidance and be actively involved in the development of the Company's investee
companies. As of December 31, 2000, the advisory board consists of seven
members. These members were granted a total of 140,000 options under the 1999
stock option plan with exercise prices ranging from $26.72 to $58.00 (weighted
average $32.58), These options vest in three equal installments on the first,
second and third anniversaries of the date of the grant. In accordance with FAS
123, the Company was amortizing to compensation expense over three years the
fair values of these options determined by the Black-Scholes option valuation
model. As a result of the Company's new strategic objectives in connection with
the Restructuring, the Company will not require substantial assistance from the
advisory board subsequent to 2000. Accordingly, the remaining value of the
related options was recognized in the fourth quarter of 2000.
Pro forma information regarding net income and earnings per share has been
determined as if the Company had accounted for its employee stock options under
the fair value method prescribed by FAS 123. The fair value for these options
was estimated at the date of grant using a Black-Scholes option pricing model
with the following weighted-average assumptions for 2001, 2000 and 1999,
risk-free interest rate of 5%, no expected dividend yield, a volatility factor
of the expected market price of the Company's common stock of .600, .600 and
1.367, respectively, and a weighted-average expected life of the option of 7
years. The lower volatility assumption used for 2000 and 2001 reflects the
estimated volatility that has occurred and is expected to continue to occur as a
result of FrontLine's revised business plan following the Restructuring.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
IV-39
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 1999, 2000 AND 2001 - (CONTINUED)
11. SHAREHOLDERS' EQUITY - (CONTINUED)
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. For the years
ended December 31, 2001, 2000 and 1999 the Company's pro forma information
follows (in thousands, except per share data):
2001 2000 1999
-------------- -------------- -------------
Pro forma net loss ............................ $ (634,509) $ (251,543) $ (43,474)
Basic and diluted net loss per share .......... $ (17.14) $ (7.21) $ (1.70)
In connection with the 1999 stock grants the Company made loans to
employees to cover the associated tax liabilities. Such loans were forgiven over
the one-year period following the date of grant. In connection with 200,000 of
the shares granted in 2000, the Company made payments on behalf of its employees
to cover the associated tax liabilities.
On December 16, 1999, the Company issued 1,437,500 shares of its common
stock in a public offering at $47.25 per share for an aggregate consideration of
$63.9 million.
During the three months ended March 31, 2000, the Company completed
preferred stock offerings of 26,000 shares of 8.875% Convertible Cumulative
Preferred Stock (the "Series A Preferred Stock") at a price of $1,000 per share
with net proceeds of $24.6 million. These shares are convertible into the
Company's common stock at a price of $70.48. The Company did not declare or pay
the quarterly dividend due on these shares on November 6, 2001 or February 6,
2002. Accordingly, future dividends will accrue at a higher rate of 10.875%. If
dividend distributions are in arrears for more than two quarterly periods, then
the holders of such shares will be entitled to elect two additional members to
the Company's Board of Directors.
On March 7, 2000, an investment partnership invested $30 million to
purchase 1.5 million warrants to acquire FrontLine's common stock at an exercise
price of $70 per share. The warrants have a term of 3.25 years. On June 29,
2000, the investment partnership invested an additional $3.0 million to obtain a
reduction in the warrant exercise price to $47.25 per share and to extend the
expiration of the warrant to March 2005. Simultaneously with this transaction,
the Company issued 1,075,000 shares of its common stock for an additional 2.5%
ownership interest in HQ Global in connection with an agreement with the
investment partnership, which had originally owned preferred stock of VANTAS.
As a result of the Series B Preferred Stock sold in December 2000, the
exercise price for the March 7, 2000 warrants was automatically decreased to
$45.01 per share.
On March 31, 2000, the Company sold approximately 2.6 million shares of its
common stock at a price of $47.25 per share for an aggregate consideration of
$122.6 million. Proceeds from the sale were utilized to repay the remaining
portion of a then-existing credit facility. As a result, certain deferred
financing costs of $2.6 million incurred in connection with the establishment of
such credit facility were expensed as an extraordinary loss in the accompanying
Consolidated Statements of Operations. As a part of this transaction, the
Company issued 128,750 warrants to purchase the Company's common stock with an
exercise price of $47.25 per share for three years.
The Company has entered into a stockholders agreement (the "HQ Stockholders
Agreement") with certain of the stockholders of HQ Global which provides them
with rights to put up to approximately 3.1 million shares of HQ Global (the "HQ
Shares") to the Company during the two years subsequent to the HQ Merger if HQ
Global has not completed an initial public offering of its shares. On February
25, 2002, such stockholders irrevocably waived their Put Rights.
On September 20, 2000, the Company issued 331,400 shares of its common
stock at a price of $15.0875 per share for gross proceeds of $5.0 million.
IV-40
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 1999, 2000 AND 2001 - (CONTINUED)
11. SHAREHOLDERS' EQUITY - (CONTINUED)
On October 17, 2000, the Company's Board of Directors announced that it
adopted a Shareholder Rights Plan (the "Rights Plan") designed to protect
shareholders from various abusive takeover tactics, including attempts to
acquire control of the Company at an inadequate price, depriving shareholders of
the full value of their investment. The Rights Plan is designed to allow the
Board of Directors to secure the best available transaction for all the
Company's shareholders. The Rights Plan was not adopted in response to any known
effort to acquire control of the Company.
Under the Rights Plan, each shareholder received a dividend of one Right
for each share of the Company's outstanding common stock owned. The Rights are
exercisable only if a person or group acquires, or announces their intent to
acquire, 15% or more of the Company's common stock, or announces a tender offer
the consummation of which would result in beneficial ownership by a person or
group of 15% or more of the common stock. Each Right entitles the holder to
purchase one one-hundreth of a share of a new series of junior participating
preferred stock of the Company at an initial exercise price of $60.00. If any
person acquires beneficial ownership of 15% or more of the outstanding shares of
common stock, then all Rights holders except the acquiring person will be
entitled to purchase the Company's common stock at a price discounted from the
then market price. If the Company is acquired in a merger after such an
acquisition, all Rights holders except the acquiring person will also be
entitled to purchase stock in the buyer at a discount in accordance with the
Rights Plan. The distribution of Rights was made to all common stockholders of
record at the close of business on November 3, 2000 and shares of common stock
that are newly-issued after that date will also carry Rights until the Rights
become detached from the common stock. The Rights expire at the close of
business on October 15, 2010, unless earlier redeemed by the Company. The Rights
distribution was not taxable to stockholders.
12. MERGER AND INTEGRATION COSTS
Merger and integration costs from continuing operations related to the HQ
Merger incurred and charged to expense during the year ended December 31, 2000
were comprised of the following (in thousands):
Payments to cancel options to purchase VANTAS common stock held by officers and
employees .................................................................... $ 11,382
Severance, retention incentives and other benefits ............................ 9,412
Professional fees and other expenses .......................................... 3,907
--------
$ 24,701
========
Of the total merger and integration costs incurred through December 31,
2000 of $24.7 million, approximately $23.4 million required cash outlays.
In connection with the HQ Merger, HQ consolidated and relocated the former
headquarters of VANTAS and Old HQ in New York, New York and Atlanta, Georgia,
respectively, into a new corporate headquarters in Dallas, Texas. Due to the HQ
Merger and relocations, VANTAS and Old HQ entered into incentive bonus
agreements with certain key executives and employees, which bonuses will be
earned as long as such executives and employees remain with HQ through a
specified date. Relocation costs and retention incentives are being charged to
expense as incurred.
HQ incurred merger and integration charges of approximately $26.7 million
during the year ended December 31, 1999, in connection with its merger
transactions in 1999 and certain transactions with FrontLine. Such charges
IV-41
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 1999, 2000 AND 2001 - (CONTINUED)
12. MERGER AND INTEGRATION COSTS - (CONTINUED)
consisted primarily of compensation expense pursuant to the transactions with
FrontLine of $23.7 million and professional fees, business process reengineering
and other integration costs, which aggregated approximately $3.0 million.
13. LONG-TERM INCENTIVE PLAN
In March 2000, the Compensation Committee of the Board of Directors adopted
a long-term incentive plan (the "LTIP"). Under the long-term incentive plan,
participants may purchase or be granted interests in limited partnerships
established by the Company to hold a profit participation interest in the
investments made by the Company. The plan contemplates the allocation to such
partnerships of up to a 12.5% profits interest in each investment made by the
Company. FrontLine, through a wholly-owned subsidiary, will act as the general
partner of each partnership and will retain an 87.5% or greater interest in each
partnership depending upon the vesting and type of interest participants
receive. FrontLine generally must receive a minimum return on its holdings in a
particular partnership, typically 100% of the cost of its investment, before
participants receive distributions from such partnership. A partnership will
generally distribute the securities or cash it holds to its partners after five
to ten years, but may distribute securities or cash earlier if the company has
completed an initial public offering or been sold. The plan also permits the
award of equivalent grants without the use of a limited partnership. In April
2000, FrontLine paid advances aggregating $2.8 million on future payments under
the long-term incentive plan to its four executive officers. During the three
months ended September 30, 2001, $1.8 million of these advances were forgiven as
a result of the termination of three of these executives. Including related
income tax accruals, the resulting expenses relating to the forgiveness of the
advances to these three executives was $2.8 million in the twelve months ended
December 31, 2001, respectively.
The Company is continuing to amortize the remaining $1.0 million and
related tax payments through April 2007, the end of the required service period,
for the remaining executive officer who is still employed with the Company.
During the twelve months ended December 31, 2001, $0.2 million of amortization
related to the LTIP was recorded.
14. RESTRUCTURING
HQ
In the second quarter of 2001, HQ initiated a restructuring program to
close certain of its business centers and eliminate certain other business
center and corporate positions. This restructuring program resulted in a charge
of $11.3 million in the third quarter of 2001 consisting of employee severance
and its estimate of future lease payments it would be required to make following
closure of the centers. Subsequent to the initiation of the plan, HQ has filed
bankruptcy and has revised its estimates of severance and lease costs based on
the expected costs of buying out its lease obligations resulting in a reduction
of accrued restructuring costs of $3.2 million in the fourth quarter of 2001.
In the fourth quarter of 2001, HQ expanded its restructuring program to
include the closure of additional business centers resulting in an additional
restructuring charge of $49.4 million consisting primarily of HQ's estimate of
the future lease payments, it will be required to make following closure of
these centers. Restructuring costs also include $5.7 million of professional
costs associated with this restructuring and HQ's Chapter 11 proceeding (see
Note 1).
IV-42
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 1999, 2000 AND 2001 - (CONTINUED)
14. RESTRUCTURING - (CONTINUED)
The following table summarizes the accrued charges related to restructuring
(in thousands):
LEASE PROFESSIONAL
SEVERANCE COSTS COSTS TOTAL
----------- ----------- ------------- ------------
Second quarter 2001 restructuring charge $ 5,317 $ 5,900 $ 108 $ 11,325
Fourth quarter 2001 restructuring charge ......... 188 43,675 5,563 49,426
Revisions of estimated costs ..................... (602) (2,596) -- (3,198)
Cash expenditures ................................ (2,208) -- (3,778) (5,986)
-------- -------- -------- --------
Balance at December 31, 2001 ..................... $ 2,695 $ 46,979 $ 1,893 $ 51,567
======== ======== ======== ========
The total restructuring program is expected to result in a net reduction of
approximately 382 employees. At December 31, 2001, the program had resulted in a
reduction of 363 employees. Severance costs are expected to be paid in 2002,
while the lease costs are expected to be paid in 2002 and future years. This
restructuring also resulted in an impairment of related fixed assets of $20.9
million and impairment of favorable leases of $4.8 million included in HQ's
fourth quarter impairment charge.
FRONTLINE
On October 18, 2000, FrontLine announced a restructuring of its strategic
plan, the steps under which are collectively referred to herein as the
Restructuring (see Note 1). In connection with the Restructuring, FrontLine
terminated approximately 90% of its headquarters personnel, which has occurred
during a transition period through the fourth quarter of 2001. As a result of
this Restructuring, FrontLine has recognized cash and non-cash restructuring
charges of $13.6 million and $12.8 million during the twelve months ended
December 31, 2001 and 2000, respectively.
The restructuring costs recognized during 2001 consist principally of (1)
$5.3 million of professional fees and other expenses, (2) $2.8 million of LTIP
costs related to three executives who were terminated in 2001, (3) $1.9 million
of severance and related payments made to employees who were terminated in 2001
and (4) $1.5 million of accelerated amortization of stock compensation and
related awards that resulted from the termination of certain employees.
Approximately $2.1 million of these costs have not been paid as of December 31,
2001.
In conjunction with the Restructuring, FrontLine re-evaluated the carrying
values of its investments and recorded aggregate impairment charges of $57.7
million through December 31, 2001 and $25.7 million in the fourth quarter of the
year ended December 31, 2000, in order to reduce the carrying value of these
investments to fair value. Such writedowns were determined in recognition of
both the lack of continuing financial support FrontLine planned to provide to
certain investees following the Restructuring and the difficult market
conditions experienced in mid-2000 and 2001. Such charges are included in
"Equity in net loss and impairment of unconsolidated companies" in the
accompanying Consolidated Statements of Operations.
15. TRANSACTIONS WITH RELATED PARTIES
HQ
HQ believes that the terms and pricing of each of the following
transactions with related parties are similar to those negotiated at arms
length. Certain officers and members of HQ's Board of Directors are also
officers and/or on the board of directors of FrontLine, Reckson Associates
Realty Corp. ("Reckson Associates"), Equity Office Properties ("EOP") or
CarrAmerica.
IV-43
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 1999, 2000 AND 2001 - (CONTINUED)
15. TRANSACTIONS WITH RELATED PARTIES - (CONTINUED)
During the year ended December 31, 2001, in connection with the June 29,
2001 Series B Preferred Stock issuance, the Company contributed approximately
$15 million in capital to HQ which has been recorded as a capital contribution.
HQ is a tenant under several leases with Reckson Associates and affiliates.
For the years ended December 31, 2001, 2000 and 1999, HQ made payments
aggregating approximately $4.7 million, $5.2 million and $3.4 million for rent,
construction and other charges under such leases.
HQ is a tenant under several leases with EOP and affiliates of EOP, which
are affiliated with EOP Operating Limited Partnership, a purchaser of HQ's
Series A Preferred Stock in conjunction with the HQ Merger. For the years ended
December 31, 2001 and 2000, HQ made payments aggregating approximately $18.6
million and $6.7 million, respectively, for rent and other charges under such
leases.
HQ is a tenant under several leases with CarrAmerica and affiliates of
CarrAmerica, who received shares of HQ's Voting Common Stock and Nonvoting
Common Stock in conjunction with the HQ Merger. For the years ended December 31,
2001 and 2000, HQ made payments aggregating approximately $3.6 million and $2.8
million, respectively, for rent and other charges under such leases.
FRONTLINE
On June 15, 1998, the Company established a credit facility with Reckson
Operating Partnership, L.P. ("Reckson"), a subsidiary of Reckson Associates, in
the amount of $100 million (the "FrontLine Facility") for their service sector
operations and other general corporate purposes. Reckson has advanced the
Company $93.4 million at December 31, 2001 under the FrontLine Facility.
Additionally, Reckson Strategic has a $100 million commitment from Reckson
to fund its investment activities (the "Reckson Strategic Facility"). Draws on
the Reckson Strategic Facility occur either in the form of loans to FrontLine
(the "Reckson Strategic Facility" and, collectively with the FrontLine Facility,
the "Credit Facilities") under terms similar to the FrontLine Facility or
whereby Reckson makes direct investments with Reckson Strategic in joint
ventures. As of December 31, 2001, Reckson has advanced FrontLine $49.3 million
under the Reckson Strategic Facility. The aggregate principal amount outstanding
and due Reckson at December 31, 2001 under both credit facilities was $142.7
million. Interest accrued on these facilities at December 31, 2001, was $34.2
million. Both of the FrontLine and Reckson Strategic Facilities expire in June
2003. Currently, the Company has an outstanding letter of credit in the amount
of $0.2 million.
In November 1999, the Boards of Directors of FrontLine and Reckson approved
amendments to the FrontLine Facility and Reckson Strategic Credit Facility
necessary in order for FrontLine to proceed with certain short-term financings
for proposed acquisitions. As consideration for such approvals, FrontLine paid a
fee to Reckson in the form of 176,186 shares of FrontLine common stock which
were valued at $20.31 per share. The fee of approximately $3.6 million was
included in deferred financing costs and was amortized over the estimated
nine-month benefit period.
On March 28, 2001, the Company's Board of Directors approved amendments to
the Credit Facilities pursuant to which (i) interest is payable only at maturity
and (ii) Reckson may transfer all or any portion of its rights or obligations
under the Credit Facilities to its affiliates. In addition, the Reckson
Strategic Facility was amended to increase the amount available thereunder to up
to $110 million. Reckson has advanced approximately $59.8 million under the
Reckson Strategic Facility to fund additional Reckson Strategic-controlled joint
ventures through December 31, 2001. There is no remaining availability under
IV-44
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 1999, 2000 AND 2001 - (CONTINUED)
15. TRANSACTIONS WITH RELATED PARTIES - (CONTINUED)
the Credit Facilities. At December 31, 2001, as a result of the Company's
failure to pay the principal and interest due upon maturity on the FrontLine
Bank Credit Facility, an event of default has occurred upon the Credit
Facilities with Reckson. As a result of the default under the Credit Facilities,
interest borrowings currently bear interest at 14.62% per annum.
The Company is entitled to a cumulative annual management fee of $2 million
with respect to Reckson Strategic, of which $1.5 million is subordinate to UBS
Real Estate receiving an annual minimum rate of return of 16% and a return of
its capital. The non-subordinated portion of the fee for the years ended
December 31, 2001, 2000 and 1999 were $0.1 million, $0.5 million and $0.5
million, respectively.
The Company reimburses Reckson with respect to general and administrative
expenses (including payroll expenses) incurred by Reckson for the benefit of the
Company. These services include payroll, human resources, accounting and other
advisory services. During 2001, 2000 and 1999, the Company incurred $0.1
million, $1.3 million and $0.5 million, respectively, for such activities.
16. BENEFIT PLAN
HQ has a 401(k) voluntary savings and investment plan (the "Plan") open to
all employees who meet certain minimum requirements. HQ can make voluntary
contributions to the Plan not to exceed 6% of eligible participant compensation.
Participants vest 100% in its contributions after 3 years of service. HQ
contributed approximately $0.9 million, $0.3 million and $0.5 million to the
Plan for the years ended December 31, 2001, 2000 and 1999, respectively. HQ
ceased contributions to the plan on November 1, 2001.
17. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES
HQ and its subsidiaries lease certain business center facilities related to
continuing operations and their corporate offices under non-cancelable operating
leases expiring at various dates through 2011. Certain of these operating leases
provide for renewal options. HQ is also generally obligated to reimburse the
lessor for its proportionate share of operating expenses, which are not included
in the minimum lease commitments below. HQ also leases equipment under operating
and capital leases which expire at various dates through 2003.
Minimum future rental payments for continuing operations under theses
non-cancelable leases for each of the next five years and in the aggregate as of
December 31, 2001 are as follows (in thousands):
CAPITAL OPERATING
LEASES LEASES
----------- -------------
2002 ................................................ $ 1,094 $ 173,709
2003 ................................................ 809 165,564
2004 ................................................ -- 153,919
2005 ................................................ -- 142,082
2006 ................................................ -- 122,817
Thereafter .......................................... -- 323,470
------- ----------
Total minimum lease payments ....................... 1,903 $1,081,561
==========
Less amount representing interest ................... (106)
-------
Present value of minimum lease commitments ......... $ 1,797
=======
IV-45
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 1999, 2000 AND 2001 - (CONTINUED)
17. COMMITMENTS AND CONTINGENCIES - (CONTINUED)
Total rent expense for the years ended December 31, 2001, 2000 and 1999 was
$223.1 million, $172.5 million and $89.9 million, respectively. Future rental
payments for office rent expense are typically subject to adjustments for
operating expenses and inflation increases as measured by the Consumer Price
Index. As of December 31, 2001, HQ has incurred $2.6 million of rent obligations
which were overdue by 30 days or more.
CUSTODIAL ACCOUNTS
HQ acts as a trustee in connection with business centers that it manages
for unrelated property owners. The cash held in trust and not reflected on the
accompanying consolidated balance sheets approximated $0.8 million and $15.8
million as of December 31, 2001 and 2000, respectively.
LITIGATION
On February 4, 1999, a lawsuit captioned OmniOffices, Inc. et al. v. Joseph
Kaidanow, et al., (Civil Action No. 99-0260) was filed in the United States
District Court for the District of Columbia. This litigation (the "D.C.
Action"), is with two stockholders of Old HQ (f/k/a OmniOffices, Inc.) and
involves the conversion of approximately $111 million of debt previously loaned
to Old HQ by CarrAmerica, into HQ's non-voting common stock. CarrAmerica and Old
HQ initiated the action by filing a complaint seeking a declaratory judgment
that the conversion price was fair, following threats by Messrs. Kaidanow and
Arcoro ("Defendants") to challenge the conversion price. Defendants filed
counterclaims against CarrAmerica, Old HQ and the then current directors of Old
HQ, seeking a judgment declaring the conversion void or voidable, or in the
alternative, compensatory and punitive damages. The stockholders' counterclaim
makes no allegations against HQ. By January 2000, discovery was complete, the
case was fully briefed, and the parties were awaiting a court ruling on HQ and
CarrAmerica's ("Plaintiffs") motion for summary judgment and Defendants' motion
to modify the scheduling order and motion to seal. The case was reassigned
twice, and the two motions were then dismissed without prejudice on September
19, 2000 and September 26, 2000. On November 13, 2000, Plaintiffs filed a motion
to reinstate their summary judgment motion. Defendants filed a cross-motion for
leave to file a cross-motion for summary judgment. The Court permitted the
refiling and took the motion and cross-motion for summary judgment under
advisement. On September 12, 2001, without holding oral argument, the Court
denied Plaintiffs' motion for summary judgment, but granted the Defendants'
cross-motion for summary judgment. Plaintiffs and the directors of old HQ filed
a Notice of Appeal in October 2001. On February 15, 2002, the D.C. Circuit
announced that oral argument was scheduled for January 16, 2003. In March 2002,
the D.C. Circuit referred the appeal to its Appellate Mediation Program.
In re HQ Global Workplaces, Inc.Shareholder Litigation, No. 17996-NC. The
original lawsuit (the "Fiduciary Action"), was brought in Delaware State
Chancery Court on April 17, 2000 by Kaidanow and Arcoro ("Plaintiffs") but was
removed to the Federal District Court for the District of Delaware and then
remanded on Plaintiffs' motion back to Delaware Chancery Court. The action
alleges a breach of fiduciary duty by CarrAmerica Realty Corporation and Old
HQ's directors in approving the HQ Merger transaction. The complaint alleges
among other things that allocation of the purchase price between the UK and U.S.
companies failed to meet the standard of entire fairness, and that CarrAmerica
breached its obligations under the Tag-Along Rights Agreement between Plaintiffs
and CarrAmerica. The lawsuit also alleges an aiding and abetting claim against
the Company as well as a tortuous interference claim against HQ and the Company.
The Plaintiffs in the Fiduciary Action have also brought an appraisal action in
the Chancery Court requesting appraisal of 100,000 of their shares sold in the
HQ Merger. Modest discovery has occurred in the Appraisal Action. The Appraisal
Action and the Fiduciary Action have now been consolidated into one action. On
March 8, 2002, Plaintiffs filed a motion for leave to amend their complaint to
add, inter alia, a breach of warrant agreements claim against HQ and other
IV-46
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 1999, 2000 AND 2001 - (CONTINUED)
17. COMMITMENTS AND CONTINGENCIES - (CONTINUED)
claims against FrontLine. On March 15, 2002, HQ filed a notice of bankruptcy
stay, stemming from its March 13, 2002 voluntary petition for Chapter 11
bankruptcy protection in the United States Bankruptcy Court for the District of
Delaware. HQ informed the Court that the consolidated action should be stayed as
to HQ pursuant to the automatic stay provisions of the Bankruptcy Code. At a
status conference held on March 25, 2002, the Vice Chancellor ordered the
parties to work out a scheduling order for the briefing of the motion regarding
the stay of the proceedings.
On or about October 3, 2001, Burgess Services, LLC ("Burgess Services"),
Dominion Venture Group, LLC ("Dominion Venture Group") and certain affiliated
parties commenced an action in Oklahoma State Court against Reckson Strategic
Venture Partners, LLP ("RSVP"), Reckson Associates Realty Corp. ("Reckson"), and
RAP-Dominion LLC ("RAP-Dominion"), a joint venture through which RSVP and
Reckson invested in a venture with certain of the plaintiffs. On April 10, 2002,
the litigation was settled without liability on the part of the Company or the
defendant. In connection with the settlement, the joint venture will be
terminated. As a result of this settlement, the Company determined that no
further impairment was necessary on its investment in Reckson Strategic.
In April 2000, the Company entered into an office lease which expires in
December 2010. In January 2001, the Company assigned the lease to HQ. The lease
assignment did not relieve the Company of any of its obligations under the terms
of this lease. At December 31, 2001, HQ was past due on $0.3 million of rent and
had a $2.8 million letter of credit outstanding with the landlord for the
office. Of the $57.6 million HQ restructuring charge recorded in 2001, a $4.8
million accrual applicable to this lease was recorded as an estimate for the
cost of terminating this lease. If the ultimate cost of terminating this lease
exceeds the outstanding letter of credit, then additional cash may need to be
paid by either HQ or the Company. Since HQ is currently in bankruptcy, the
landlord is likely to seek to recover any further damages from FrontLine. As of
December 31, 2001, the remaining lease commitment in excess of the existing
letter of credit was $24.2 million.
The Company also has potential liability under its indemnification of
CarrAmerica for liabilities of Carr America under its guarantees relating to
five HQ leases. In conjunction with the HQ Merger, FrontLine agreed to indemnify
CarrAmerica for its guarantees of certain HQ leases. At December 31, 2001, HQ
had $1.4 million in outstanding letters of credit associated with these 5
leases. Of the $57.6 million HQ restructuring charge recorded in 2001, a $2.3
million accrual applicable to this lease was recorded as an estimate for the
cost of terminating these leases. As of December 31, 2001, the remaining lease
commitments in excess of the existing letter of credit was $25.4 million.
In addition to the cases set forth above, the Company and its investee
entities are party to claims and administrative proceedings arising in the
ordinary course of business or which are otherwise subject to indemnification,
some of which are expected to be covered by liability insurance (subject to
policy deductibles and limitations of liability) and all of which, including
IV-47
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 1999, 2000 AND 2001 - (CONTINUED)
17. COMMITMENTS AND CONTINGENCIES - (CONTINUED)
the cases discussed above, collectively are not expected to have a material
adverse effect on the Company's financial position or results of operations.
Management does not anticipate that these legal litigations will negatively
impact future operations of the Company.
18. QUARTERLY FINANCIAL DATA (UNAUDITED)
The following summary represents the Company's results of operations for
each quarter during 2001 and 2000 (in thousands, except share amounts):
FIRST SECOND THIRD FOURTH
2001 QUARTER QUARTER QUARTER QUARTER
- ---- -------------- -------------- ------------- -------------
Total revenues ..................................... $ 137,442 $ 123,151 $ 108,700 $ 101,414
Total expenses ..................................... 156,543 170,701 458,358 434,057
Equity in net loss and impairment of
unconsolidated companies .......................... (9,958) (1,416) (24,031) (1,043)
Minority interest .................................. (1,532) 10,511 105,364 191,641
Net loss ........................................... (30,216) (39,072) (256,556) (298,982)
Net loss applicable to common Shareholders ......... (33,208) (40,009) (257,495) (299,696)
Basic and diluted net loss per weighted average
common share ...................................... $ (0.91) $ (1.08) $ (6.93) $ (8.02)
Basic and diluted weighted average common
shares outstanding ................................ 36,660,417 36,876,113 37,180,073 37,369,705
FIRST SECOND THIRD FOURTH
2001 QUARTER QUARTER QUARTER QUARTER
- ---- -------------- -------------- ------------- -------------
Total revenues ..................................... $ 62,420 $ 95,219 $ 147,886 $ 149,965
Total expenses ..................................... 81,587 127,399 165,483 175,167
Equity in net loss and impairment of
unconsolidated companies .......................... (18,294) (34,453) (31,106) (42,075)
Minority interest .................................. 902 196 (4,416) (4,370)
Net loss ........................................... (39,966) (66,249) (53,814) (72,749)
Net loss applicable to common
shareholders ...................................... (40,311) (66,826) (54,390) (73,370)
Basic and diluted net loss per weighted
average common share .............................. $ (1.27) $ (1.92) $ (1.49) $ (2.00)
Basic and diluted weighted average
common shares outstanding ......................... 31,717,891 34,889,374 36,574,462 36,664,644
IV-48